Effective retroactive to January 1, 2023, Pennsylvania Act 34 excludes up to $5,000 per year of benefits under an IRC Section 129 dependent care assistance program from Pennsylvania state income tax and withholding. Because the law was enacted in late December 2023, the Pennsylvania Department of Revenue provided instructions for correcting Box 16 of the 2023 Pennsylvania Form W-2. (See Tax Alert 2024-0586.)

The dependent care assistance exclusion also applies to most local payroll taxes. Under Section 501 of the Local Tax Enabling Act, taxable wages for purposes of the local Earned Income Tax and Local Services Tax are those wages subject to Pennsylvania state income tax. All Pennsylvania localities are governed by the Local Tax Enabling Act except for Philadelphia, which is governed by the Sterling Act. Under Philadelphia's regulations, dependent care assistance benefits continue to be subject to its Wage Tax.

Ernst & Young LLP insights

In addition to box 16 of the 2023 Pennsylvania Form W-2, the reduction for dependent care assistance benefits should also be made to Box 18 of the 2023 Pennsylvania Form W-2 for the Earned Income Tax and Local Services Tax. No adjustment should be made for Philadelphia's Wage Tax because dependent care assistance benefits continue to be taxable.