New IRS Guidance Simplifies Dependent Care FSA Nondiscrimination Testing

On August 11, 2026, the IRS and Treasury Department issued proposed regulations explaining how nondiscrimination rules apply to Dependent Care Assistance Programs and the new Section 128 Trump Account programs.

While the regulations are technical, the overall message is positive: the new guidance provides clearer and more practical rules that could make it easier for employers to offer these benefits.

What Is a Dependent Care Assistance Program?

A Dependent Care Assistance Program, or DCAP, allows employees to use pre-tax dollars for eligible childcare and dependent care expenses. A Dependent Care Flexible Spending Account, commonly called a Dependent Care FSA or DCFSA, is one way employers can provide this benefit.

For plan years beginning after December 31, 2025, the annual contribution limit increases from $5,000 to $7,500. The limit for married individuals filing separately increases from $2,500 to $3,750.

To keep these benefits tax-free, the plan must pass annual nondiscrimination testing. These tests are designed to ensure the program does not unfairly favor highly compensated employees or company owners.

For more than 40 years, employers have had limited formal guidance on how some of these requirements should be applied. The proposed regulations provide much-needed clarification.

The Four Main DCAP Requirements

A dependent care program generally must pass four tests:

1. Benefits Must Be Offered Fairly

Eligible employees must be offered the benefit under the same terms. A plan is not automatically considered discriminatory simply because lower-paid employees choose to participate at a lower rate.

2. Eligibility Rules Must Be Fair

The requirements used to determine which employees are eligible cannot disproportionately favor highly compensated employees.

3. Benefits for Certain Owners Are Limited

Individuals who own more than 5% of the business cannot receive more than 25% of the total dependent care benefits provided through the plan.

4. The Plan Must Pass the 55% Average Benefits Test

On average, the benefits received by employees who are not highly compensated must equal at least 55% of the average benefits received by highly compensated employees.

What Problems Do the Proposed Regulations Address?

Common Challenge	Previous Concern	What the Proposed Rules Clarify
Lower participation among lower-paid employees	A plan could appear discriminatory when eligible employees chose not to contribute because they could not afford to set money aside.	When all eligible employees receive the same offer, lower participation alone does not necessarily mean the plan is discriminatory.
Uncertainty surrounding the 55% test	It was unclear whether employees who declined the benefit had to be counted as receiving $0. Including them could significantly lower the plan’s average and cause it to fail.	Only employees who actually make or receive a contribution are included in the calculation. Employees who do not participate are excluded.
Unclear eligibility standards	Employers did not have a clear way to demonstrate that eligibility requirements, such as limiting the plan to full-time employees, were fair.	The regulations provide a mathematical safe harbor that employers may use to evaluate their eligibility rules.
No clear way to address a failed test	When a plan failed testing, highly compensated employees could unexpectedly lose the tax-free treatment of their benefits.	The proposed rules provide a process for addressing certain failures by reporting excess benefits as taxable income on Form W-2 before the applicable filing deadline.

The Most Important Change for Employers

One of the biggest improvements involves the 55% Average Benefits Test.

Under the proposed guidance, employees who do not make or receive a contribution through the dependent care program are not included in the calculation.

For example, imagine that an employer offers the same Dependent Care FSA to 100 eligible employees, but only 20 decide to enroll. Under the new interpretation, the test would focus on those 20 participating employees rather than treating the other 80 employees as receiving a $0 benefit.

This change could help many employers pass nondiscrimination testing more easily. The IRS and Treasury Department have also indicated that employers may begin relying on this interpretation now.

How Could This Affect Dependent Care FSAs?

The increased $7,500 contribution limit raised concerns that employers might hesitate to adopt the higher limit because of potential testing failures.

The new guidance may reduce those concerns. As a result, more employers may feel comfortable:

• Offering a Dependent Care FSA
• Increasing their existing plan to the new $7,500 limit
• Allowing employees to receive greater tax savings
• Continuing to offer the benefit without nonparticipants negatively affecting the 55% test

Plans that experienced testing difficulties in previous years may also receive different results when applying the clarified calculation.

How Does This Apply to Trump Accounts?

The regulations also address Section 128 Trump Account programs created under the One Big Beautiful Bill Act.

Trump Accounts are tax-advantaged savings accounts for children. The law allows employers to make up to $2,500 per year in tax-free contributions to the Trump Accounts of their employees’ dependents.

These employer programs are subject to fairness requirements similar to those that apply to dependent care programs. The clarified nondiscrimination rules, including the treatment of individuals who do not receive contributions, could make Trump Account programs more practical for employers to offer.

What Should Employers Do Next?

Employers should review the proposed regulations with their benefits administrator and consider how the guidance may affect their current plan.

Important next steps may include:

• Reviewing current eligibility requirements
• Evaluating the plan’s nondiscrimination testing procedures
• Determining whether nonparticipating employees were previously included in the 55% test
• Considering an increase to the new $7,500 contribution limit
• Exploring whether a Trump Account contribution program could benefit employees

OCA Benefit Services can help employers and benefit advisors understand the updated rules, evaluate their current plan designs, and prepare for future testing requirements. Contact OCA to learn more about Dependent Care FSA administration and nondiscrimination testing.