What Is Section 129 Non-Discrimination Testing for Dependent Care Assistance Programs?

Section 129 non-discrimination testing is a compliance requirement under the Internal Revenue Code to ensure that Dependent Care Assistance Programs (DCAPs) do not favor highly compensated employees (HCEs) or key employees at the expense of non-highly compensated employees (NHCEs). These programs allow employees to use pre-tax dollars to pay for eligible dependent care expenses, offering significant tax savings. However, to retain their tax-advantaged status, DCAPs must pass three key tests annually.

1. Eligibility Test: This test ensures that the plan does not disproportionately exclude NHCEs. Employers must verify that the plan's eligibility requirements are inclusive and do not favor HCEs or key employees.
2. Contributions and Benefits Test: This test evaluates whether contributions and benefits are provided fairly across all participants. It ensures that the plan does not disproportionately favor HCEs or key employees in terms of the amount or value of benefits received.
3. 55% Average Benefits Test: This test requires that NHCEs receive at least 55% of the total benefits provided under the DCAP. It is designed to ensure that the majority of the plan's benefits are directed toward non-highly compensated employees.

If a DCAP fails any of these tests, the tax-advantaged dependent care benefits provided to HCEs and key employees may become taxable income. This would reduce the value of the program for these individuals and could lead to IRS penalties or increased scrutiny for the employer.

Employers should perform non-discrimination testing for their DCAPs at least annually, preferably before the plan year ends, to identify and correct potential issues. Employee demographics, participation rates, and contribution levels can all impact the outcome of these tests. Many organizations use third-party administrators or compliance platforms to streamline the testing process and ensure accurate results.

By complying with Section 129 non-discrimination rules, employers can maintain the tax benefits of their DCAPs, promote equitable access to dependent care support, and demonstrate a commitment to fairness in their benefits offerings.

References

1. Internal Revenue Code § 129. Retrieved from https://www.law.cornell.edu/uscode/text/26/129
2. Internal Revenue Service. (n.d.). Tax Benefits for Dependent Care. Retrieved from https://www.irs.gov/pub/irs-pdf/p503.pdf
3. Society for Human Resource Management. (2023). Best Practices for Managing Dependent Care Assistance Programs. Retrieved from https://www.shrm.org

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