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Dependent Care Refund - How to show on W2

Last year we failed our Dependent Care testing and so I was instructed to show the reimbursements received by the employees as taxable income on the W2. One employee's CPA however, is saying that the pre-tax deduction should also be removed from the W2. I am very confused. It seems to me that the pre-tax deduction should show on the W2 and the reimbursements show as taxable. Can anyone help me? I am getting bombarded from all corners.


  • If your plan failed, I'm assuming that the salary reduction agreement also failed. The salary reduction should be reversed. That is, pretax deductions should be reduced by the amount that is disallowed and taxable wages increased by that same amount. The employees should receive a cash refund for the disallowed salary reduction equal to the amount of disallowed pretax deductions minus any reimbursements already paid out under the disallowed plan.

    For example, during the year an employee had $4,000 deducted pretax and received $3,000 in disallowed benefits (reimbursements) from the plan. The employer must refund the excess of contributions over reimbursements of $1,000 to the employee because, presumably, the reduction of salary is not valid and the employee must be paid their otherwise full compensation. The reversal of the pretax deduction increases taxable wages by the $4,000 the employee should have received as wages absent a qualified plan allowing the salary reduction.

    The reversal means that the employer did not provide any dependent care benefits and the employee may be able to claim some or all of the dependent care tax credit what would have been reduced by employer provided qualified dependent care (the amount that is reportable in box 10 of the W-2. Any amount reported in box 10 reduces or eliminates the credit the employee may claim on the employee's tax return.

    If the employer made disallowed pretax deductions from employee pay, it is actually a wage underpayment. The reversal of the pretax deductions results in an increase in taxable gross pay due to the employee subject to withholding of the appropriate taxes. Simply adding the reimbursements to the taxable wages on the W-2 does not quite do the trick.