Q&A: What Do Employers Need to Know About the New Dependent Care FSA Limits?

Question:

I recently saw the new 2026 contribution limits for flexible spending accounts. With the dependent care FSA contribution limits increasing, it could present a challenge for us, such as difficulties in meeting nondiscrimination testing requirements. Could you please clarify why this might occur? What is the impact of this higher limit on employers? Additionally, what are the advantages and disadvantages associated with this change?

Answer:

When the “One Big Beautiful Bill” was signed into law earlier this year, it increased the maximum contribution limit for dependent care FSA (DCFSAs) from $5,000 to $7,500. Unlike the Health FSA contribution limits, which will increase from $3,300 to $3,400, the DCFSA limit does not automatically increase with inflation.

With that said, here are some key points to keep in mind about the increase:

1. Employers may increase their DCFSA limit beginning in 2026, but are not required to do so. You can always set lower FSA contribution limits than the law allows.
2. In general, I agree that increasing the DCFSA limit may increase the risk for employers of failing nondiscrimination testing. In short, the testing is to ensure that cafeteria plans do not disproportionately favor higher-paid employees. However, for many employers, those employees are more likely to contribute the full $7,500 limit than lower-paid employees. I think that is a relatively small factor in the employer’s decision whether to increase the limit.
3. Reasons to consider increasing the limit include:

• DCFSA limits have been $5,000 since 1986 (other than a brief COVID-era change), so the increase is long overdue. The annual cost of full-time childcare for even one child is likely to be far more than $7,500. Employees who utilize the DCFSA for part-time care (and therefore have lower childcare costs) can always choose to contribute less than the max.
• Increasing the limit may result in increased tax savings not only for employees but for employers as well, who will pay less in payroll taxes for Social Security and Medicare.
• FSA administrators should be able to assist their clients on the nondiscrimination issue. For example, they could run next year’s test using this year’s participation numbers, assuming that participation will be similar next year. This wouldn’t be a foolproof approach, but it could help clients identify situations in which there is clearly a concern.

Finally, keep in mind that even if a DCFSA fails nondiscrimination testing, this does not have significant negative consequences. The primary effect is that certain contributions made by highly compensated participants may need to be retroactively reclassified as taxable income. There is no impact on lower-paid participants.