By Pension and Benefits Editorial Staff
The IRS has issued guidance that clarifies the application of temporary special rules for health flexible spending arrangements (FSAs) and dependent care assistance programs (DCAPs) under cafeteria plans pursuant to Section 214 of the Taxpayer Certainty and Disaster Tax Relief Act of 2020 (the Act), recently enacted as Division EE of the Consolidated Appropriations Act, 2021 (P.L. 116-260). Specifically, Act Sec. 214:
- provides flexibility with respect to carryovers of unused amounts from the 2020 and 2021 plan years,
- extends the permissible grace period for plan years ending in 2020 and 2021,
- provides a special rule regarding post-termination reimbursements from health FSAs,
- provides a special carryover rule for DCAP when a dependent "ages out" during the public health emergency posed by COVID-19, and
- allows certain mid-year election changes for health FSAs and DCAPs for plan years ending in 2021.
Prior IRS guidance (see Notice 2020-29, I.R.B. 2020–22, May 26, 2020) provided flexibility to employers with cafeteria plans through the end of calendar year 2020, during which employers could permit employees to apply unused health FSA amounts and DCAP amounts to pay for or reimburse medical care or dependent care expenses. The Act, signed into law on Dec. 27, 2020, provides similar flexibility for these arrangements in 2021 and 2022.
Carryovers. Pursuant to Act Sec. 214, an employer may amend one or more of its cafeteria plans to provide a carryover of all or part of the unused amounts remaining in a health FSA or a DCAP as of the end of a plan year ending in 2020 or 2021 to the immediately subsequent plan year. For example, if an employer sponsored a calendar year cafeteria plan in 2020 with a health FSA that provides for a $550 carryover, 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). 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.
The guidance indicates the carryover is available to cafeteria plans that currently have a grace period or provide for a carryover, as well as plans that currently do not have a grace period or provide for a carryover, notwithstanding Notice 2013-71, which otherwise continues in effect and provides that health FSAs can either adopt a grace period or provide for a carryover amount but cannot have both. In addition, an employer may limit the carryover to an amount less than all unused amounts and may limit the carryover to apply only up to a specified date during the plan year.
For purposes of determining whether an eligible individual qualifies 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 (HDHP) (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 the individual participates in a general purpose health FSA to which unused amounts are carried over pursuant to Act Sec. 214. Employers may also amend their plans to allow employees, on an employee-by-employee basis, to opt out of the carryover to preserve their HSA eligibility.
Grace periods. The guidance’s clarifications are similar regarding extended grace periods for a health FSA or DCAP. An employer may amend one or more of its cafeteria plans to permit employees to apply any unused amounts remaining in a health FSA or a DCAP as of the end of a plan year ending in 2020 or 2021 to reimburse expenses incurred for the same qualified benefit (medical care or dependent care) up to 12 months after the end of the plan year.
Post-termination reimbursements. In addition, Act Sec. 214(c)(2) provides that a plan that includes a health FSA will not fail to be treated as a cafeteria plan merely because the plan or arrangement allows (under rules similar to the rules applicable to a DCAP) an employee who ceases participation in the plan during calendar year 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 period, taking into account any modification of a grace period permitted under Act Sec. 214(c)(1)) .
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.
With respect to the extension of the period for incurring claims for an employee who ceases to be a participant, 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 termination of employment, change in employment status, or a new election during calendar year 2020 or 2021. Finally, the extension period is limited to the end of the plan year in which participation ceased.
Age limit relief. The guidance provides that if an employer sponsors a cafeteria plan with a DCAP and amends the plan to substitute “under age 14” for “under age 13” for purposes of determining the dependent care assistance expenses that may be paid or reimbursed, then all amounts from the most recent plan year with respect to which the end of the regular enrollment period was on or before January 31, 2020, may be applied to dependent care expenses for a dependent who attained age 13 during that plan year.
In addition, employers may allow employees to carry over all unused amounts from that plan year (the first plan year) to reimburse dependent care expenses during the subsequent plan year for a dependent that attained age 13 during the first plan year (until that dependent attains age 14) and for a dependent who attains age 13 during the subsequent plan year. This special age limit relief for DCAP does not apply to any unused amounts carried over from the subsequent plan year. This special age limit relief rule also does not permit an employer to reimburse expenses for a child who is age 14 years or older.
Mid-year election changes. The notice also provides additional relief with respect to mid-year elections for plan years ending in 2021. Specifically, with respect to employer-sponsored health coverage, a cafeteria plan may permit employees who are eligible to make salary reduction contributions under the plan to take any of the following actions for plan years ending in 2021:
- make a new election on a prospective basis, if the employee initially declined to elect employer-sponsored health coverage,
- revoke an existing election and make a new election to enroll in different health coverage sponsored by the same employer on a prospective basis, and
- 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.
An employer is not required to provide unlimited election changes but may, in its discretion, determine the extent to which election changes are permitted, provided that any permitted election changes are applied on a prospective basis only. The guidance notes that in determining the extent to which election changes are permitted and applied, an employer may wish to consider the potential for adverse selection of health coverage by employees. To prevent this result, an employer may wish to limit elections to circumstances in which an employee’s coverage will be increased or improved as a result of the election (for example, by electing to switch from self-only coverage to family coverage, or from a low option plan covering in-network expenses only to a high option plan covering expenses in or out of network).
With respect to mid-year election changes for employer-sponsored coverage, this relief applies both to employers sponsoring self-insured plans and to employers sponsoring insured plans. With respect to health FSAs, this relief applies to all health FSAs, including HSA-compatible health FSAs. In addition, with respect to health FSAs and DCAPs, employers are permitted to limit mid-year election changes to amounts no less than amounts already reimbursed and to certain types of mid-year election changes, such as decreases in elections only.
Employers also are permitted to allow mid-year election changes without a status change up to a certain date during the plan year but require a status change after that date (for example, no status change is required if an election is changed before March 31, 2021, but a status change is required if an election is changed after that date), and to limit the number of election changes during the plan year that are not associated with a status change (for example, allow only one election change in the 2021 plan year without a status change).
Interaction with COBRA. The guidance indicates that if an individual is otherwise a qualified beneficiary with respect to coverage by a health FSA, a limited extension of coverage to the individual pursuant to Act Sec. 214(c)(2) will not prevent the individual from having a loss of coverage resulting in a qualifying event (for example, by termination of employment or reduction in hours of a covered employee), and the relevant employer will be required to provide a notice of the right to elect COBRA continuation coverage to the individual.
For example, if an employer allows an employee who ceases to be a participant as the result of termination of employment or change in employment status to be reimbursed for expenses incurred after the termination or reduction in hours through access to the amount of salary reduction contributions that have been made as of the date the employee ceased being a participant, this event would constitute a COBRA qualifying event subject to notice requirements.
As a further example, if an employee elected to contribute $2,400 to a health FSA, terminated employment on January 31 after making $200 in salary reduction contributions, and as a result of the termination was no longer permitted to contribute to the health FSA other than by electing COBRA continuation coverage, the employer may allow the employee to request reimbursement for up to $200, or the employee may elect COBRA continuation coverage to have access to $2,400 by paying the applicable COBRA premium of $200 per month on an after-tax basis.
Plan amendments. An employer that decides to implement the relief provided under Act Sec. 214 for one or more of its cafeteria plans (including plans that do not currently have a grace period or permit a carryover) must adopt a plan amendment to do so. An amendment may be effective retroactively to the beginning of the applicable plan year, provided the cafeteria plan operates in accordance 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, and the employer informs all employees eligible to participate in the cafeteria plan of the changes to the plan.
SOURCE: IRS Notice 2021-15; IR-2021-40, February 18, 2021.
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