On February 18, 2021, the Internal Revenue Service (IRS) issued clarifying guidance on the temporary special rules for health flexible spending arrangements (FSAs) and dependent care assistance programs (DCAPs) under Internal Revenue Code (Code) Section 125 cafeteria plans. See IRS Notice 2021-15 (the Notice).
As discussed in our On the Subject, the Consolidated Appropriations Act (the CAA) establishes temporary special rules for FSAs, such as giving employers the option to amend their cafeteria plans and health FSAs and DCAPs to allow employees to carry over unused amounts into 2021 and 2022 or extend the grace period in 2021 and 2022. The CAA also includes the option to make prospective election changes for plan years ending in 2021, without regard to whether the employee experiences a change in status, and a number of other changes.
IRS Notice 2021-15 clarifies the treatment of carryovers of FSA and DCAP funds, extended grace periods, post-termination health FSA reimbursements and DCAP age limit relief. The guidance also explains:
How employees can make prospective mid-year election changes to FSAs for plan years ending in 2021
How an employer may amend one or more of its cafeteria plans to adopt these new provisions
Options to preserve health savings account (HSA) eligibility for health FSA carryovers and extended grace periods
How the carryovers and extended grace periods interact with other rules, such as nondiscrimination rules
Form W-2 reporting requirements for DCAPs
How employers can amend their plans to adopt the Coronavirus Aid, Relief and Economic Security Act (the CARES Act) provision allowing expenses incurred for over-the-counter drugs and menstrual care products to be treated as incurred for medical care with respect to health FSAs and HSAs.
McDermott Callout: These provisions are entirely at the discretion of the employer. None of the options above are mandatory. We suggest checking in with employees and running forfeiture reports to determine if your employees would benefit from this Notice.
FSA/DCAP Grace Periods and Carryovers
An employer, in its discretion, may amend its Section 125 cafeteria plan to provide a carryover of all or part of the unused amounts remaining in a health FSA or DCAP as of the end of a plan year ending in 2020 or 2021 into the next plan year.
The IRS provided the example of an employer that sponsored a calendar year cafeteria plan in 2020 with a health FSA that provides for a $550 carryover. In this case, the employer may amend the plan to carry over the entire unused amount remaining in an employee’s health FSA as of December 31, 2020, to the 2021 plan year (even if that amount exceeds $550). Similarly, the employer also may amend the plan to carry over the entire unused amount remaining in an employee’s health FSA as of December 31, 2021, to the 2022 plan year.
This Notice applies to all health FSAs, including limited-purpose health FSAs, as well as all DCAPs. However, health FSA amounts may be used only for medical care expenses, while DCAP amounts may be used only for dependent care expenses. Further, the relief is available for plans that have a grace period or carryover as well as those that have not adopted either feature. The rule prohibiting the implementation of both a grace period and a carryover is still in effect and will apply in full to these plans again once the relief in the Notice ends. An employer that decides to adopt this elective relief may limit the carryover to an amount less than all unused amounts and/or may limit the carryover to apply only up to a specified date during the plan year.
The Consolidated Omnibus Budget Reconciliation Act (COBRA) election rights for a health FSA will not be impacted by the grace period extension or carryover relief. In addition, if an employer adopts the carryover or grace period extension allowed under the CAA (the applicable COBRA premium payable to provide access to such carryover amounts) the amount attributable to the extended period is zero. Amounts carried over or available during the extended period for incurring claims are included in the amount of benefits to which a qualified beneficiary is entitled during the remainder of a plan year in which a qualifying event occurs. In accordance with the otherwise applicable rules, for plan years ending in or after 2022, the carryover is available only for a health FSA and is not available for a DCAP.
McDermott Callout: The guidance provides for a lot of flexibility for employers wanting to implement these options; however, the IRS holds firm on the idea that a plan may not offer a grace period and a carryover. The IRS also held firm on HSA eligibility (see below).
HSA Eligibility and Carryovers/Grace Periods
Unfortunately, for purposes of determining whether an eligible individual is qualified to make contributions to an HSA, the carryover of unused amounts to the 2021 plan year or the 2022 plan year is an extension of the coverage by a health plan that is not a high-deductible health plan (except in the case of an HSA-compatible health FSA, such as a limited-purpose health FSA). Therefore, an individual is not eligible to make contributions to an HSA during a month in which they participate in a general-purpose health FSA to which unused amounts are carried over pursuant to this Notice. Note, however, that the IRS indicates that individuals may opt out of any such carryover or grace period to preserve their HSA eligibility.
Extended Claims Period after Termination of Participation in FSA
A health FSA may allow an employee who ceases participation in the plan during 2020 or 2021 to continue to receive reimbursements from unused benefits or contributions through the end of the plan year in which participation ceased (including any grace periods). DCAPs currently have this ability.
An employer may choose to adopt an extended period for incurring claims that is less than 12 months, and an employer may choose to adopt a period that ends before the end of the plan year during which employees who have ceased participation in a plan may continue to receive reimbursements.
The employer, in its discretion, is permitted to limit the unused amounts in the health FSA to the amount of salary reduction contributions the employee had made from the beginning of the plan year in which the employee ceased to be a participant up to the date the employee ceased to be a participant. This option is available for an employee who ceases to be a participant as the result of (i) termination of employment, (ii) change in employment status or (iii) a new election during 2020 or 2021. The extension period is limited to the end of the plan year in which participation ceased (including any grace period).
Subject to the nondiscrimination rules under Code Sections 125 and 129, employers may adopt this relief for some, but not all, health FSA or DCAP participants. Amounts carried over or available during an extended claims period are not taken into account for purposes of the nondiscrimination rules applicable to cafeteria plans and DCAPs under Code Section 129.
Special Age Limit Relief Applicable to Carryover Relief for Dependent Care Assistance Programs
The CAA provides that in the case of certain employees, “age 14” replaces “age 13” for purposes of determining the dependent care assistance which may be paid or reimbursed during (A) the last plan year for which the end of the regular enrollment period for such plan year was on or before January 31, 2020, and (B) in the case of an employee who has an unused balance in a DCAP for such plan year (determined as of the close of the last day on which, under the terms of the plan, claims for reimbursement may be made with respect to such plan year), the subsequent plan year. Employers may limit the reimbursements under the DCAP to the amounts paid for dependent care assistance that does not exceed the employee’s unused balance.
Only certain employees are eligible for this relief: employees who (A) are enrolled in a DCAP for the last plan year for which the end of the regular enrollment period for the plan year was on or before January 31, 2020, and (B) have one or more dependents (as defined in Code Section 152(a)(1)) who attain the age of 13 either (i) during that plan year or (ii) in the case of an employee who has unused dependent care amounts for that plan year (determined as of the close of the last day on which, under the terms of the plan, claims for reimbursement may be made with respect to that plan year), during the next plan year.
Elections under a Cafeteria Plan
Subject to certain limitations, an employer may amend one or more of its cafeteria plans to allow employees, on a prospective basis, to (1) revoke an election, make one or more elections or increase or decrease an existing election, for plan years ending in 2021 regarding a health FSA or (2) revoke an election, make one or more elections or increase or decrease an existing election, for plan years ending in 2021 regarding a DCAP.
Prospective election changes may include an initial election to enroll in a health FSA or DCAP for the year, for example, to gain use of the carryover or extended period for incurring claims (discussed above) if the employee initially declined to enroll in the health FSA or DCAP for the year.
An employer adopting this relief may limit the period during which election changes may be made. An employer adopting this elective relief may also limit the extent to which election changes are permitted, as long as such limits are implemented in a nondiscriminatory way (e.g., limiting elections to circumstances in which an employee’s coverage will be increased or improved as a result of the election, such as by electing to change from self-only coverage to family coverage, or from an in-network plan to a plan that covers expenses in- or out-of-network). The Notice further provides additional relief with respect to mid-year elections for employer-sponsored health coverage. For plan years ending in 2021, a Section 125 cafeteria plan may permit eligible employees to: (1) make a new election on a prospective basis, if the employee initially declined to elect employer-sponsored health coverage, (2) revoke an existing election and make a new election to enroll in different health coverage sponsored by the same employer on a prospective basis or (3) revoke an existing election on a prospective basis, provided that the employee attests in writing that the employee is enrolled, or immediately will enroll, in other health coverage not sponsored by the employer.
Cafeteria plans may allow prospective mid-year election changes during plan years ending in 2021 in any of the following situations:
New elections for employer-sponsored health coverage by employees who initially declined coverage.
Elections to enroll in different health coverage sponsored by the same employer (including a change from self-only to family coverage).
Revocation of existing elections for employer-sponsored health coverage, with a written attestation that the employee is or immediately will be enrolled in other health coverage not sponsored by the employer.
This is similar to relief issued by the IRS in IRS Notice 2020-29 as described in our previous article here. The Notice includes sample attestation language. Employers may rely on the employee’s written attestation unless the employer has actual knowledge that the employee is not or will not be enrolled in other comprehensive health coverage not sponsored by the employer.
McDermott Callout: Employers will want to provide notice to employees of any modifications made to the plan under this guidance, most likely in the form of a Summary of Material Modifications (SMM).
An employer that decides to implement this elective relief for its cafeteria plan (including plans that do not currently have a grace period or permit a carryover) must adopt a plan amendment to do so. In general, amendments to cafeteria plans should be adopted prior to the effective date of the amendment. However, an amendment may be adopted retroactively for these provisions, if (1) the amendment is adopted not later than the last day of the first calendar year beginning after the end of the plan year in which the amendment is effective and (2) the plan or arrangement is operated consistent with the terms of the amendment during the period beginning on the effective date of the amendment and ending on the date the amendment is adopted.
The IRS provided the example of an employer that sponsors a calendar year cafeteria plan with a health FSA that provides for a $550 carryover (from 2020 to 2021) and amends the plan to carry over the entire unused amount remaining in employees’ health FSAs as of December 31, 2020, to the 2021 plan year. In this case, the amendment must be adopted by December 31, 2021. However, for a non-calendar year plan, an amendment for the 2020 plan year must be adopted by December 31, 2022, because the last day of the first calendar year beginning after the end of the 2021 plan year is the last day of 2022.
Reporting Requirements for DCAPs
Amounts contributed to a DCAP are required to be reported in Box 10 of Form W-2. Employers may report in Box 10 the annual salary reduction amount elected by an employee for dependent care assistance, without adjusting the amount reported in Box 10 to take into account amounts that remain available in a grace period. This rule continues to apply with respect to employers who amend their cafeteria plans to provide for the temporary flexibility provided by the CAA.
The CARES Act amended the Code to allow health FSAs, HSAs, health reimbursement arrangements (HRAs) and Code Sec. 220 Archer medical savings accounts (MSAs) to reimburse expenses incurred for menstrual care products and over-the-counter drugs without regard to whether the drug has been prescribed to be treated. This expansion applies to expenses incurred after December 31, 2019.
Health FSAs and HRAs may be amended pursuant to this Notice to provide for reimbursements of expenses for menstrual care products and over-the-counter drugs without prescriptions incurred for any period beginning on or after January 1, 2020.
The Notice provides welcome guidance regarding the application of relief provided by the CAA. For further details regarding the Notice or information about how to apply this relief, contact one of the authors or another McDermott Employee Benefits lawyer.