At the end of 2020 Congress enacted the Taxpayer Certainty and Disaster Tax Relief Act of 2020, which was part of the Consolidated Appropriations Act, 2021. The new legislation includes provisions that allow for additional flexibility for flexible spending accounts (“FSAs”) under IRC Section 125. These provisions, which apply to both health FSAs and dependent care FSAs, are temporary. More recently in February of 2021, Notice 2021-15 was issued providing further guidance for FSAs. This article focuses on the new guidance and its impact on health and dependent care FSAs.
Carryovers vs. Grace Periods –What’s the difference?
Under generally applicable law not taking into account the new legislation, employers with health FSAs can permit employees to carry overtheir balances that were unused at the end of a plan year to be used to pay medical expenses incurred during the following plan year. The carryover amount is subject to an indexed dollar limit ($550 for carryovers from plan years beginning in 2020 to plan years beginning in 2021) and is not available for dependent care FSAs. As an alternative, employers can provide employees with a grace period (a period of up to two months and 15 days at the start of the following plan year) within which to apply their unused health and dependent care FSA balances to pay expenses incurred during the grace period. Employers with health FSAs must choose whether to use a grace period or a carryover, but not both.
In response to the COVID-19 emergency, Notice 2020-29 was issued in recognition that employees were more likely to have unused health and dependent care FSA balances at the end of plan years or grace periods ending in 2020. As a result, this notice permitted employers to extend the time, to the end of calendar 2020, during which employees could apply unused FSA balances.
COVID Carryovers
Newly-enacted legislation permits employers to provide a carryover of unused FSA account balances remaining at the end of a plan year to a subsequent plan year. Specifically, unused account balances for both health and dependent care FSAs can be carried over from plan years ending in 2020 to plan years ending in 2021. In addition, balances can be carried over from plan years ending in 2021 to plan years ending in 2022. These special temporary carryovers are permitted for cafeteria plans that currently have a grace period notwithstanding the prohibition applicable to health FSAs that employers may not have both a carryover and a grace period and the prohibition on carryovers for dependent care FSAs. Employers can choose to limit the carryovers authorized by the new legislation (a “COVID carryover”) by limiting the amount of an unused account balance that can be carried over or by limiting the time period during which the carryover will apply. Carryovers from a health FSA can only be used to pay medical expenses, and carryovers from a dependent care FSA can only be used to pay dependent care expenses.
COVID Grace Periods
The new legislation also permits employers to provide an extended period (a grace period) to apply unused FSA account balances. The grace period authorized by the new legislation (a “COVID grace period”), which is permitted only for plan years ending in 2020 or 2021, can extend for up to 12 months after then end of the plan year. Similar to COVID carryovers, a COVID grace period may be adopted by a employer that has an existing carryover notwithstanding the prohibition applicable to health FSAs that employers may not have both a carryover and a grace period. Employers can choose to limit the COVID grace period to a period of less than 12 months.
Spend Down for Terminating Participants
Under proposed Treasury Regulations, an employer may permit an employee with a dependent care FSA who ceases participation in the cafeteria plan to be reimbursed for dependent care expenses incurred after the date participation ends through the end of the plan year or a grace period following that plan year. The new legislation has a similar provision that applies for health FSAs, but only for an employee whose participation in the plan ends during calendar years 2020 and 2021. Employers are permitted to limit the unused amounts that may be used to reimburse medical expenses to the amount that the employee contributed during the plan year in which the employee terminates participation. This is an important limitation that employers will want to consider in order to reduce the potential for unexpected employer liability. Even if an employer adopts this special limited extension of coverage, an employee whose participation ends may nonetheless experience a loss in coverage (for example, if coverage ends on account of a termination of employment) that will trigger COBRA.
For the purpose of the spend down for health FSAs, the period during which reimbursable expenses must be incurred can extend beyond the plan year in which the participant terminates participation(that is, into the grace period for that plan year) only if the employer has not adopted a COVID carryover for that plan year. For example, if an employee has a unused balance and terminates participation mid-plan year, reimbursement of expenses incurred in the following plan year would only be allowed if the employer has not adopted a COVID carryover. Employers should be mindful of this restriction when choosing between a COVID carryover or a COVID grace period.
Election Changes
Available During 2021Toallow further flexibility, the new legislation permits employees to make prospective mid-year election changes with respect to their FSAs during plan years ending in 2021. Thus, an employer may, but is not required to, amend its cafeteria plan to provide for these election changes regardless of whether the employee has a change in status. Employers may limit the number of changes that are permitted or the time periods during which changes are permitted. Employers also may limit changes so that the total amount contributed is no less than amounts already reimbursed. Contributions made after an election change may be used for expenses incurred during any part of the plan year.
An employer may also allow employees who previously did not elect to participate inan FSA for the 2021 plan year to join mid-year, for example, so that the participant may utilize an unused balance from the 2020 plan year. An employer may permit employees to revoke their election, so that no further contributions may be made. For employees who elect to revoke their elections, employers may provide that no further reimbursements will be made.
Special Relief for Dependent Care FSAs
The new legislation provides special relief for dependent care FSAs when an employee’s dependent ages out during the COVID emergency. Under this relief, a special carryover is allowed for employees who have an unused balance in their dependent care FSA for the last plan year for which the open enrollment period ends on or before January 31, 2020, have one or more dependents who attain age 13 in that plan year or the subsequent plan year (the 2019 and 2020 plan years for a plan with a calendar plan year).
Plan Amendments
As outlined above, the new legislation and the guidance under Notice 2021-15 allow many alternative plan designs for employers that want to provide added flexibility to their employees with FSAs that will avoid the forfeiture of unused balances. Employers that elect to take advantage of the relief provided must amend their plan documents. Retroactive amendments are permitted so long as the plan is operated consistent with the terms of the amendment beginning with the effective date of the amendment and employees are notified of the changes. Plans must be amended by the last day of the first calendar year beginning after the end of the plan year in which the amendment is effective. For example, if an employer that has a plan with a calendar plan year desires to add a COVID grace period that will apply to unused balances at the end of the 2020 plan year must adopt appropriate plan amendments by the end of 2021.
Employers should give special attention to preserving an employee’s eligibility to make HSA contributions. A COVID carryover adopted for a general purpose health FSA will disqualify an otherwise eligible individual from contributing to an HSA. There are, however, different plan designs that will facilitate continued HSA eligibility.
Employers should keep in mind that the relief provided under the new legislation and Notice 2021-15 is voluntary. Employers will have many plan design choices to make. Before moving forward with a particular plan design, employers should consult with their third-party administration firms to ensure that the design can be administered properly. Attorneys at Boutwell Fayare happy to discuss plan design changes to take advantage of the this special COVID relief and to prepare the appropriate plan amendments.
© Boutwell Fay LLP 2021, All Rights Reserved. This handout is for information purposes only and may constitute attorney advertising. It should not be construed as legal advice and does not create an attorney-client relationship. If you have questions or would like our advice with respect to any of this information, please contact us. The information contained in this article is effective as of March2021.