Think you can delay paying any tax on your Dependent Care FSA? Here’s why the IRS isn’t buying it

Jenny and her husband are expecting their second child and have scheduled their maternity leave from work for 12 weeks. Jenny is now seven months pregnant, which means she’s about to go into the final month of her maternity leave. She wanted to ask me if she could delay paying into her dependent care FSA for an extra year. My view is that I’m willing to work with Jenny for one more year, but I can’t agree to her demand to reduce the amount she contributes to her FSA.

Jenny explained that she owes $15,800, the maximum contribution to her account at age 20. Jenny felt that if she deferred all of her FSA payments for the last eight weeks of her pregnancy, she would be able to pay off her balance by the time she was ready to return to work in late 2019.

“If I were in your shoes, I would have made the same request,” Jenny told me. “But I had other commitments. And I didn’t want to stop drawing on my 401(k) because of this tax change.” Jenny added that because her husband works for a company with tax-deferred retirement plans, she has no need to use the FSA. Her advice to other people with dependent care FSAs is to talk to their HR departments and to make sure that if they contribute to the FSA this year, they will pay attention to the rules.

Jenny’s request to postpone her FSA contributions until after she returns to work fell in line with the IRS 2015 policy for those with Dependent Care FSAs. Starting in August 2019, the maximum contribution will decrease from $5,800 per person to $4,300. Jenny said she would save $1,800 of her current $15,800 balance in her dependent care FSA.

“Then, if she were still in her job in 2019, she would be able to contribute the full $5,800 to her account and would not owe the tax withholding portion,” said a federal tax specialist who has been advising people on tax issues.

Jenny informed me that she was open to paying the tax withholding portion of her FSA in the future. She explained that she made the decision to delay her contributions because she had planned to contribute to her FSA in 2019 even though she believed she would not be in her job by then.

The labor law issue

Under the terms of the Labor Department’s Dependent Care FSA regulations, you are allowed to postpone any FSA contributions until a year after you retire. However, while Jenny was too young to be in a job for the full year after her last paycheck was due, she would have been eligible to contribute for the entire year that she was eligible for her company’s 401(k) or 457 retirement plans.

“As you can imagine, it’s very complex,” said Liz Claiborne New York’s Director of Tax Services, Michael Birsh. “It’s important that the person is eligible to make those contributions and the employer is aware that you are.”

Birsh said that under the current IRS 2015 policy, Jenny could delay her withholding until March 2019, when she would be eligible to contribute to her company’s 401(k) or 457. However, since Jenny is still young, she could postpone her FSA contributions until May 2019. In both cases, Jenny would owe the tax withholding portion of her contributions and not pay the tax because she is now older than 35.

Because of its age restriction, the Dependent Care FSA is often an overlooked retirement investment tool, according to PNC Financial Services Group.

“Younger employees may be overwhelmed by the complexity of using a flexible spending account to pay for child care,” said Executive Vice President of Retirement Solutions at PNC Ed Acheson. “If you can wait until you’re financially prepared to use it, many employers offer high-cost/low-benefits accounts, such as an FSA, for your family’s needs.”

“If you are prepared and want to make the largest allowable contribution, including withholding the tax, set up a calendar year end balance check, and then make your final payment between the new tax due date (January 1) and your April Filing Due Date (May 15),” Acheson added.

If you miss the deadline to pay the penalty for failing to file a tax return, you could be forced to pay interest on that penalty.

Jenny’s problem

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