School is Closed – Now What? Considerations for Employers & Childcare Benefits Due to Coronavirus Closures

As New York City, the country’s largest school system, announced that it will close schools until April 20^th and possibly longer, along with many other school districts and daycares doing the same, employers will want to address the issue of their employees’ changing childcare needs.  One of the bills issued by Congress in response to the coronavirus, the Families First Coronavirus Response Act (signed by the President on March 18^th) (the “Act”), mandates that employers with fewer than 500 employees provide paid leave (after 10 days) to employees who are unable to work (or even telework) in order to care for their children now that schools are closed.  The law also applies when employees have to care for children who had been in now-unavailable paid childcare.  The paid leave under the Act is two-thirds of pay, limited to a maximum of $200 per day and $10,000 total.  While we will be providing more in-depth guidance on the specifics of this paid leave, for employers that have more than 500 employees or wish to provide additional options, this Client Alert offers considerations for employers navigating issues with keeping employees working but also recognizing employees are dealing with childcare issues.  If you would like to discuss the possibility of implementing any of these options or about making midyear election changes, please contact one of the Hunton Andrews Kurth lawyers listed below.

 1. Employer Stipends or Reimbursements for Childcare

One of the quickest and simplest means for employers to assist employees with unexpected dependent care costs is to provide employees with a stipend or reimbursement for such costs.  In general, an employer-paid dependent care stipend or reimbursement would constitute additional wages to the employee (subject to income tax withholding and employment taxes) absent a basis for treating the payment as nontaxable. The advantages to providing this type of taxable financial assistance to employees are that there is no limit to the amount that may be provided and such amounts would not be subject to nondiscrimination requirements, unlike dependent care flexible spending accounts discussed below. However, consideration should be given to how this may affect employees’ wages for purposes of the Fair Labor Standards Act (“FLSA”) compliance and overtime calculations.      

We note that there has been some discussion about whether the President’s recent declaration of the coronavirus pandemic as a national emergency under the Robert T. Stafford Disaster Relief and Emergency Assistance Act permits employers to offer nontaxable “qualified disaster relief payments” to employees under Section 139 of the Internal Revenue Code. At this time, however, it is not clear whether this emergency declaration triggers Code Section 139.  Until the IRS provides further guidance, employers should not rely on Code Section 139 as a means of providing tax-free benefits to their employees. 

2. Employer Contributions to Dependent Care Flexible Spending Accounts

As an alternative to taxable stipends, employers may consider making contributions to employees’ dependent care flexible spending accounts (FSAs), which can be done on a tax-free basis if specific IRS requirements are met.

Any dependent care FSA payments for childcare expenses incurred as a result of the coronavirus-related school closures will need to be subject to appropriate documentation, as with any other dependent care expenses reimbursed through an FSA. Contributions to dependent care FSAs also come with additional restrictions that would not apply to taxable stipends. For example, the FSA rules only allow payments to family members providing dependent care if the family member does not meet any of the following criteria: (i) can be claimed as a dependent, (ii) is a child under 19, (iii) is a person who was a spouse any time during the year, or (iv) is the parent of the child who is under age 13.

One potential logistical challenge to making employer dependent care FSA contributions mid-year is the annual limit on overall contributions. Both employer and employee contributions are subject to an aggregate limit of $5,000 for individuals or married couples filing jointly (or $2,500 each, for married couples filing separately). If an employee has already elected to make the maximum pre-tax contributions to their dependent care FSA for 2020, then any employer contributions would reduce the employee’s permitted pre-tax contributions to the dependent care FSA. If the contributions are not reduced and as a result the employee (and his/her spouse, if applicable) ends up with over $5,000 in dependent care FSA contributions for the year, the excess amounts will be taxable income.

Under IRS rules, all contributions to the dependent care FSA will be subject to nondiscrimination testing requirements; if the contributions do not pass testing, then any excess amounts contributed on behalf of highly compensated employees will become taxable. Finally, if the employer does not currently make dependent care FSA contributions, adding an employer contribution will likely require a plan amendment to permit this type of contribution.

3. Permissible Midyear Election Changes for Dependent Care FSAs

Employees may also seek to make changes to their own dependent care contributions in light of the changing childcare and workplace landscape. Most dependent care assistance programs are FSAs through which contributions are made on a pre-tax basis through a cafeteria plan and are therefore subject to the irrevocable election requirement under Code Section 125, except in the case of a permitted election change event.  Undoubtedly, school and daycare closures and the like will generate corresponding requests from employees to make midyear election changes to their dependent care FSA elections. In particular, we expect that employers will see an uptick in requests to decrease or stop their dependent care FSA contributions because their childcare provider has closed.  Or, in some cases, employees may be looking to increase their dependent care FSA contributions to cover unexpected dependent care costs incurred as a result of school closures. 

In general, if provided for under an employer’s cafeteria plan, a change in the number of hours for a current dependent care provider, a significant cost change in childcare (so long as the provider is not a relative), or a change in dependent care providers will justify a corresponding midyear election change to the dependent care FSA.  Employers should check their cafeteria plan document regarding midyear election changes to determine whether such changes are allowed.

4. Employer Fringe Benefits for Childcare Assistance

Employers may need to get creative about how it can help their workforces continue to work while schools are closed and childcare options, such as daycare, may also be closed or limited.  Below are some additional ideas companies can implement during this period:

Engage services of a tax preparation company to help employees navigate the business and tax complexities of hiring a nanny or childcare professional.  For employees who need to seek in-home care during this period and have not employed a nanny before, the steps to comply with the tax, unemployment and withholding rules can be daunting.  Companies could engage tax preparation services and pay directly for employees’ use of such services to help employees meet the numerous obligations for hiring and compensating a nanny or other childcare professional.  The fair market value of company-provided tax preparation services would be included in the employee’s gross income and subject to employment taxes.   

Leave-sharing and vacation donation policies for employees to donate unused leave time. Companies can set up leave-sharing and vacation donation banks for employees who wish to donate their accrued and unused sick, vacation or paid time off leave to other employees who cannot work due to the coronavirus in order to continue to receive paid leave during this exceptional period.   While there are tax advantages for leave-banks for employees who take time off due to medical emergencies (such as a COVID-19 diagnosis) or due to a declared disaster (which has not yet occurred by the President), simply providing leave sharing for covering time off to take care of children would not qualify for specific tax relief.  As such, employees who contribute leave time would have taxable income equal to the fair market value of the contributed leave and the employee receiving the paid leave would owe taxes on the leave he or she receives.