Canada (EN)
Employer-sponsored Dependent Care Flexible Spending Accounts (DCFSAs) remain an important benefit for working families managing childcare and dependent care expenses. Beginning in 2026, interest in these plans increased as the annual dependent care exclusion limit rises from $5,000 to $7,500 under recent federal legislation.
At the same time, employers have long faced a compliance challenge: satisfying the Dependent Care Assistance Program (DCAP) 55% Average Benefits Test. Newly proposed IRS regulations released on August 11, 2026 could provide welcome clarity and make compliance easier for many employers.
Why the 55% test matters
The 55% Average Benefits Test is designed to ensure dependent care benefits do not disproportionately favor highly compensated employees (HCEs).
To pass the test, the average benefit received by non-highly compensated employees (NHCEs) must equal at least 55% of the average benefit received by HCEs. If a plan fails, HCEs may lose some or all of the tax-free treatment of their dependent care benefits.
Historically, employers have struggled with this test because it was unclear whether employees who were eligible for a DCFSA but chose not to participate should be included in the calculation.
The proposed change
The most significant clarification in the proposed regulations is that employers would calculate the 55% test using only employees who actually participate in the dependent care program.
Employees who are eligible but do not enroll would no longer be included in the calculation. This change could significantly improve testing results, particularly for employers with lower participation rates among NHCEs. By focusing on employees who actually receive benefits, the proposed approach may provide a more accurate measure of benefit distribution and reduce the likelihood of test failures.
How the Test Works
Average NHCE benefit ÷ Average HCE benefit = Test result
Passes at 55% or higher
| Example 1 | Example 2 | |
$5,000 ÷ $7,500 66.7% | $4,000 ÷ $7,500 53.3% |
The proposed regulations also reaffirm that certain employee groups may be excluded from testing, including some employees under age 21, employees with less than one year of service, eligible collectively bargained employees and, in certain salary reduction arrangements, employees earning less than $25,000 annually.
Key dates
The guidance is proposed and has not yet been finalized. Key milestones include:
- August 11, 2026: Proposed regulations published
- September 25, 2026: Public comments due
- October 15, 2026: Public hearing scheduled
If finalized, the regulations would apply to plan years beginning on or after publication of the final rule.
What employers should do now
Although the regulations are proposed, employers are permitted to rely on them immediately. Employers should also monitor the rulemaking process and evaluate how the final regulations could affect future nondiscrimination testing results and whether they can be applied to prior years. For many organizations, the proposed regulations represent a simplification rather than an added compliance burden.
As a best practice, employers may want to perform a preliminary review after annual enrollment and another review later in the plan year. Early testing can help identify potential compliance concerns, provide time for corrective action and reduce the risk of unexpected tax consequences for HCEs.
If finalized, the proposed rules could make nondiscrimination testing more predictable and easier to pass, helping employers continue to offer valuable dependent care benefits while maintaining compliance with tax requirements.
