In 1986, a gallon of gas cost about 89 cents and Congress set the dependent care FSA limit at $5,000. The gas price moved. The FSA limit didn't — for four straight decades, while the average annual price of child care climbed to $13,184 in 2025, your employees' pre-tax cap stayed frozen at roughly a third of that bill.
That finally changed. For plan years beginning after December 31, 2025, the annual limit on excludable dependent care assistance jumped from $5,000 to $7,500 per employee ($3,750 for someone married filing separately). It's the first permanent increase since 1986, it came in via the 2025 federal tax law, and — this is the part most small employers miss — it does not apply to your plan automatically. The statute raised the ceiling. Your plan document, payroll system, and open enrollment materials still control what your employees can actually elect.
If any of those still say $5,000, this is the year to fix them.
What Exactly Changed
Under Section 129 of the tax code, an employee can exclude dependent care benefits from taxable income up to an annual cap. The new numbers, confirmed in the 2026 edition of IRS Publication 15-B:
- $7,500 per year for single filers and married couples filing jointly (up from $5,000)
- $3,750 for married employees filing separately (up from $2,500)
- Effective for plan years beginning after December 31, 2025 — so calendar-year plans have been operating under it since January 1, 2026, and non-calendar-year plans pick it up at the start of their 2026 plan year
- Not indexed for inflation. This is a fixed change in federal law, not the start of an annual adjustment cycle
The benefit itself is unchanged in structure: it's still a salary-reduction account inside your Section 125 cafeteria plan, used for care that lets the employee (and spouse) work — daycare, preschool, before- and after-school care, summer day camps, and care for a spouse or dependent who can't care for themselves. Kids must be under 13 when the care is provided.
One more statutory detail worth knowing: the exclusion can never exceed the earned income of the employee or their spouse, whichever is smaller. A spouse who isn't working and isn't a student generally zeroes out the benefit. You don't police that on the payroll side, but it explains why some employees will decline to participate no matter how good the math is.
What the Raise Is Actually Worth
An extra $2,500 of pre-tax money is real money, and the savings land on both sides of the payroll register:
- Employee side: the extra $2,500 escapes federal income tax and FICA (7.65%). For an employee in the 22% bracket, that's roughly $550 in income tax plus about $191 in FICA — around $741 a year in combined savings, before any state income tax benefit.
- Employer side: you don't pay the 7.65% employer match on excluded amounts either — another ~$191 per participating employee, every year, at no cost to you.
Against a $13,184 average annual child care bill, $7,500 covers well over half of it pre-tax. At the old $5,000 limit, coverage was closer to a third. That difference is why benefits advisors are telling employers to treat this as a retention headline for the fall open enrollment season, not a footnote.
The Catch: The Raise Doesn't Apply Until You Amend
Here is the trap. Congress changed the statutory maximum. Your cafeteria plan document — or your TPA's adoption agreement — still contains a hard-coded election ceiling, and for most plans written before 2026 that ceiling is $5,000. Until the document is amended, your payroll system is correctly rejecting elections above the old number.
Your pre-open-enrollment checklist:
1. Amend the plan document or adoption agreement
Work with your benefits administrator or TPA to adopt the $7,500 ceiling for the 2026 plan year and beyond. Most standardized adoption agreements have already been updated by their sponsors, but adopting the new version is still your action to take, not something that happens by default.
2. Update payroll election caps
Whatever payroll platform you use, the DCAP salary-reduction cap needs to allow $7,500. If you also fund any employer contributions (some employers seed accounts to drive participation — more on why below), those count toward the same $7,500 ceiling, not on top of it.
3. Fix open enrollment materials and default elections
Enrollment screens, comparison sheets, and stale "$5,000 max" boilerplate in your handbook all need the new number. If you ran a calendar-year plan and let employees increase their 2026 election mid-year when the law changed, confirm the full-year amounts carried into your payroll correctly — mid-year election changes are permitted when the plan document allows them, and several administrators began allowing them specifically because of this statute change.
4. Brief employees before they elect
The election decision is genuinely more complicated this year (see the coordination issue with the child care credit below). A one-page explainer during open enrollment prevents both under-election and angry questions in January.
The Compliance Angle Most Small Employers Don't See Coming
Dependent care FSAs must pass nondiscrimination tests under Section 129, and the higher limit makes one of them meaningfully harder. The 55% Average Benefits Test requires that the average DCAP benefit going to non-highly compensated employees (NHCEs) equal at least 55% of the average benefit going to highly compensated employees (HCEs). For 2026, an HCE is generally a more-than-5% owner or an employee who earned over $160,000 in the prior year.
Why the risk goes up: HCEs are the employees most likely to max out the new $7,500. Lower-paid employees may contribute less — or skip the FSA entirely because the child and dependent care credit pays them more per dollar at their income. When owners and executives pile into a bigger account while rank-and-file participation stays thin, the average benefits ratio sours, and the penalty is unpleasant: HCEs lose the tax exclusion, their DCAP amounts go back into taxable wages, and you're issuing corrected W-2s.
Practical mitigations, in ascending order of effort:
- Run preliminary testing during or right after open enrollment, while you can still adjust elections, instead of discovering a failure at year-end testing.
- Educate NHCEs — even small elections from lower-paid staff move the average, and many don't realize the benefit covers elder care and summer camps, not just daycare.
- Tier the limits: the plan can set a lower ceiling (say, $5,000) for HCEs while letting everyone else elect the full $7,500, or exclude HCEs from the DCAP altogether.
- Seed small employer contributions for non-HCEs to lift the NHCE average — weighed against whether those employees actually have care expenses, since DCAP money is generally use-it-or-lose-it.
The Small-Employer Escape Hatch: Simple Cafeteria Plans
If you average 100 or fewer employees, there's a cleaner path. A simple cafeteria plan — available to employers that averaged 100 or fewer employees in either of the two preceding years and meet simple eligibility and contribution requirements — is treated as automatically satisfying the cafeteria plan nondiscrimination rules, including the ones that bite dependent care programs.
The trade-off is a modest employer contribution to every qualified employee: either a uniform percentage of at least 2% of compensation for each qualified employee, or the lesser of 6% of compensation or twice the employee's own salary-reduction contributions. For a small business that was going to seed DCAP participation anyway, that's often a double win — a hiring-friendly benefit plus nondiscrimination safe harbor, without testing anxiety.
Don't Double-Dip: The FSA and the Child Care Credit
The same expenses can't be paid twice. Amounts reimbursed through a dependent care FSA reduce, dollar for dollar, the expenses eligible for the child and dependent care tax credit on Form 2441 — and the credit's own expense caps ($3,000 for one qualifying person, $6,000 for two or more) are unchanged and now sit below the FSA limit. An employee with two kids who maxes the $7,500 election zeroes out the credit entirely; a partial election of, say, $4,000 against $8,000 of real expenses leaves $2,000 of creditable dollars under the $6,000 cap. Both vehicles can be used — on separate dollars.
That math creates the planning conversation your employees need to have:
- For higher earners, the FSA usually wins outright: $7,500 excluded from income escapes a 22%+ marginal rate plus 7.65% FICA — north of $2,200 a year — while the credit's applicable percentage slides to 20% at higher incomes, worth at most $1,200 on the two-child cap.
- For lower earners, the credit's 2026 rate curve is newly generous: it starts at 50% for households with AGI up to $15,000 and holds a 35% plateau through much of the middle class, so per-dollar it can outrun the FSA's flat exclusion. It's still nonrefundable, though, so a household with little federal income tax liability gets nothing from it — while the FSA cuts FICA at any income.
The second bullet is exactly why some non-highly compensated employees rationally decline the FSA — and exactly why your average benefits test needs watching.
A two-minute example in your open enrollment materials — one higher earner and one moderate earner, both run through the FSA-versus-credit math — does more for participation quality than any blanket "max it out!" advice.
The Bookkeeping Trail: W-2 Box 10 and Reconciliation
The payroll consequences of getting this right are concrete, and they show up on the forms:
- Box 10 of Form W-2 reports the total dependent care assistance for the year — the nontaxable portion up to $7,500 and any excess above it.
- Any amount over $7,500 (or otherwise failing exclusion, like an HCE after a failed nondiscrimination test) goes into Boxes 1, 3, and 5 as taxable wages with withholding.
- IRS Publication 15-B gives a clean illustration: an employee with $7,000 of FSA salary reduction plus $700 of employer-provided on-site care reports $7,700 in Box 10, of which $200 is added to taxable wages.
On the general-ledger side, keep the DCAP records clean all year: elections versus actual reimbursements by employee, substantiation status of pending claims, and the forfeited balances from use-it-or-lose-it participants. Dependent care accounts don't get the health FSA carryover option (plans can offer a grace period of up to 2½ months instead — set the claim deadline deliberately and communicate it), so forfeiture accounting is a real line item. A simple monthly reconciliation of the DCAP clearing account — payroll deductions in, approved reimbursements out, forfeitures recognized — turns year-end W-2 reporting and Form 2441 questions into a lookup instead of an archaeology project. If you track this in plain-text accounting, the per-employee election cap is just another assertion you can validate against payroll each period.
Simplify Your Financial Management
A benefits change like this one lands squarely on your books — election caps in payroll, taxable pickups in W-2 boxes, forfeited account balances, and nondiscrimination test results all need a reliable record behind them. Beancount.io provides plain-text accounting that gives you complete transparency and version control over every transaction, from DCAP reimbursements to quarterly payroll summaries. Get started for free and see why developers and finance professionals are switching to accounting they can actually read, audit, and trust — and check the documentation for payroll and expense-tracking workflows you can adopt this week.