IRS Proposes New Dependent Care FSA Nondiscrimination Rules for 2026

Every employer offering a dependent care flexible spending account has run nondiscrimination testing under IRC Section 129 for decades, but the statute itself has never had detailed regulations explaining exactly how to run the tests or fix a failure. That changed on August 10, 2026. Treasury and the IRS released proposed regulations that, for the first time since the rules were written, spell out the mechanics of all four dependent care nondiscrimination tests and give employers a documented way to correct a failed test. Here is what the proposed rules cover, why the timing matters for the new $7,500 contribution limit, and what an employer should check before the plan year closes.

What Did the IRS Just Propose for Dependent Care FSA Testing?

The Treasury Department and the IRS proposed the first detailed regulatory framework for Section 129 dependent care assistance program nondiscrimination testing in more than 45 years. The proposed rules were released August 10, 2026, and lay out how to run each of the four statutory tests, how to measure eligibility and benefits across a workforce, and how an employer can correct a test that fails rather than simply losing the plan's tax-favored status. Until this release, employers and their advisors had leaned on decades-old informal guidance and industry practice to interpret a statute that Congress wrote in 1981 and never substantially updated with implementing regulations.

What Are the Four Dependent Care Nondiscrimination Tests?

A dependent care assistance program has to pass four separate tests under IRC Section 129 every plan year, and the new proposed regulations address all four directly.

• The eligibility test, under Section 129(d)(2), requires that the plan not discriminate in favor of highly compensated employees in terms of who can participate.
• The contributions and benefits test, under Section 129(d)(3), requires that contributions or benefits under the plan not favor highly compensated employees compared to other participants.
• The more-than-5%-owners concentration test, under Section 129(d)(4), caps the share of total benefits paid to employees who own more than 5% of the business at 25% of total benefits provided.
• The average benefits test, under Section 129(d)(8), requires the average benefit provided to non-highly-compensated employees to equal at least 55% of the average benefit provided to highly compensated employees.

The average benefits test is the one most employers actually fail, since it compares average dollars used, not just plan eligibility, and a workforce where higher earners disproportionately elect the benefit can fall short of the 55% threshold even when every employee was technically eligible to participate.

Why Did the IRS Release This Now?

The timing connects directly to the new, much higher dependent care FSA limit. The One Big Beautiful Bill Act raised the 2026 dependent care FSA contribution limit under IRC Section 129 to $7,500 for a married couple filing jointly, up from $5,000, the first increase since 1986. Several employers and benefits consultants flagged a real concern once that limit took effect: if highly compensated employees are more likely to max out a bigger $7,500 election while lower-paid employees contribute a smaller, flatter amount regardless of the higher ceiling, the average benefits test gets harder to pass, not easier, even though the increased limit was designed to help families. The proposed regulations respond to that concern directly, and employers can rely on them for 2026 testing before they are finalized, which matters for any employer running year-end testing on a calendar-year plan.

What Correction Options Does the Proposed Rule Provide?

The proposed regulations give employers documented correction mechanisms for a failed test, rather than leaving employers to guess at a fix based on informal practice. A failed nondiscrimination test under prior guidance generally meant the excess contributions of highly compensated employees became taxable income, reported as wages rather than excluded dependent care benefits. The proposed regulations formalize how that correction is calculated and applied, giving payroll and benefits teams a clearer standard to follow when a test comes back short instead of relying on the informal approaches many third-party administrators have used for years.

When Do the Proposed Regulations Take Effect?

The regulations are proposed, not final, and the IRS has opened a formal comment period. Comments are due 45 days after the rule is published in the Federal Register, and a public hearing is scheduled for October 15, 2026. Employers are not required to wait for a final rule. The IRS has stated that taxpayers may rely on the proposed regulations now, which means an employer running dependent care nondiscrimination testing for the 2026 plan year can apply this new framework today rather than waiting for the comment period and hearing to close.

Does This Change How the Section 129 Tests Interact With Section 125?

A dependent care assistance program is almost always offered as one qualified benefit inside a broader <a href="/blog/section-125-cafeteria-plan-2026-guide">Section 125 cafeteria plan</a>, and the Section 129 nondiscrimination tests run separately from the Section 125 cafeteria plan tests covering the plan as a whole. Passing the Section 125 eligibility and contributions tests does not automatically mean the dependent care benefit inside that same plan passes its own four Section 129 tests, since the two sets of rules measure different things using different employee populations and different thresholds. An employer that has never failed its overall Section 125 testing can still fail the dependent care average benefits test specifically, which is exactly the scenario the new proposed regulations were written to address with more clarity than employers had before August 2026.

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Frequently Asked Questions

Sources: U.S. Department of the Treasury and Internal Revenue Service proposed regulations under IRC Section 129, released August 10, 2026; IRC Section 129(d); the One Big Beautiful Bill Act (Public Law 119-21).