Reminder: Dependent Care Assistance Is Now Excludable in Pennsylvania, Retroactive to 2023 Tax Year

Quick Hits

• Pennsylvania amended its tax law to make amounts contributed to dependent care assistance excludable for income tax purposes.
• The change aligns Pennsylvania with the federal treatment and is retroactive for the 2023 tax year.
• Employers may have withheld taxes on dependent care assistance contributions and may have issued Forms W-2 that overstated income.

On December 13, 2023, Pennsylvania enacted House Bill (HB) 1300, which changed the state’s treatment of dependent care assistance as a taxable benefit. The change brought Pennsylvania into conformity with its treatment under federal tax law, which allows employees to exclude from income up to $5,000 (or $2,500, if married and filing separately) contributed to dependent care assistance programs.

However, given how late in the year the change was made, many employers likely withheld Pennsylvania income tax from employees on this assistance throughout the 2023 year. Further, many employers may have also been unaware of the change when issuing Forms W-2 to employees and did not make necessary adjustments, creating issues for employees filing their Pennsylvania Personal Income Tax Return (PA-40).

Dependent Care Assistance Programs

Section 129 of the federal Internal Revenue Code (IRC) allows employers to provide dependent care assistance benefits that are excluded from employees’ income for federal tax purposes. Employers can provide dependent care assistance programs or flexible spending accounts (FSAs) that enable employees to make pre-tax contributions of up to $5,000 each year (or up to $2,500 each year, if married and filing separately). However, dependent care assistance benefits have not been excludable for Pennsylvania income tax purposes.

HB 1300 resolves this discrepancy to align Pennsylvania with the federal treatment. Specifically, the law provides that “amounts paid or incurred by an employer of an employe[e] for dependent care assistance provided to the employe[e] that are excludable under 26 U.S.C. § 129 … may not be included in any of the classes of income enumerated.” Importantly, this change is retroactive to January 1, 2023.

According to the Pennsylvania Department of Revenue, dependent care assistance covered by HB 1300 includes:

• “the fair market value of benefits provided in kind by the employer”;
• “an amount paid directly to a daycare facility by the employer or reimbursed to the employee to subsidize the benefit”; or
• “benefits from the pre-tax contributions made by the employee under a section 125 [of the IRC] dependent care flexible spending account.”

What to Do

Many employers in Pennsylvania may not have made the necessary adjustment in advance of issuing employees their Forms W-2 for 2023. As such, the Pennsylvania Department of Revenue has issued guidance for affected employers and employees.

The Department of Revenue has instructed employers to do the following:

1. Provide employees with corrected Forms W-2 and alert them of the change.
2. File updated forms, if Forms W-2 have not been filed with the department, “in which the dependent care benefits reported in box 10 are not included in box 16, State Wages.” The amount cannot exceed $5,000 for the 2023 tax year, the department stated.
3. Only amend Form W-2 compensation and not file amended Forms W-3 and Annual Withholding Reconciliation Statements that remove the previous withholding.
4. “Stop withholding for tax year 2024 on dependent care benefits (up to $5,000).”

The department has instructed employees to do the following:

1. Ask employers for a corrected Form W-2 if the prior form does not take into account the updated treatment of contributions to dependent care assistance programs before filing a Pennsylvania tax return.
2. File a tax return with corrected amounts by decreasing the wages in box 16 by the dependent care benefits and using that amount. The department tells employees in such a case to “[i]nclude the W-2 along with a written statement from your employer to verify why the amounts on the W-2 do not match the amount reported.”

Next Steps

Employers in Pennsylvania may want to take note of the updates made by HB 1300 and review whether they made the necessary adjustments to employees’ Forms W-2. If employers have issued Forms W-2 to employees that include amounts contributed to dependent care assistance programs in employees’ taxable wages, employers may want to consider issuing corrected forms or written statements to employees to verify amounts employees self-correct.

Ogletree Deakins will continue to monitor developments and will provide updates on the Employee Benefits and Executive Compensation and Pennsylvania blogs.

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