Starting January 1, 2026, the annual contribution limit for dependent care assistance programs (DCAPs) will increase from $5,000 to $7,500 (or $3,750 if married filing separately), marking the first adjustment in decades. Adopting this higher limit is optional, but employers wishing to do so for 2026 need to act now.

Action Items for Employers:

• Decide whether to adopt the new $7,500 limit for 2026.
• Amend plan documents and update employee communications and open enrollment procedures accordingly.
• Coordinate with payroll and administrators to ensure systems and testing procedures are ready for the new limit.
• Review historical participation data to model whether the higher cap could trigger testing failures and consider conducting prospective testing. DCAPs remain subject to IRS nondiscrimination rules (e.g., the 55% average benefits test), and higher limits could make testing more challenging if participation is concentrated among highly compensated employees.

This change is a welcome enhancement for employers and employees with significant dependent care expenses. The higher DCAP limit can provide meaningful additional savings on federal income taxes for employees and on FICA (Social Security and Medicare) taxes for employees and employers. For example, assume an employee has a 20% effective federal income tax rate and has not met the Social Security wage limit. By excluding an additional $2,500 of income under a DCAP, the employee would save an additional $500 in federal income taxes and both the employee and the employer would save an additional $191.25 in FICA taxes.