Pension & Benefits News IRS relaxes Sec. 125 plan rules due to COVID-19, increases FSA carryover amount
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Monday, May 18, 2020

IRS relaxes Sec. 125 plan rules due to COVID-19, increases FSA carryover amount

By Pension and Benefits Editorial Staff

The IRS has released Notices 2020-29 and 2020-33 to provide flexibility under Sec. 125 due to the COVID-19 pandemic. Under Notice 2020-29, the IRS provided increased flexibility with respect to 2020 midyear elections under a Code Sec. 125 cafeteria plan related to employer-sponsored health coverage, health flexible spending arrangements (health FSAs), and dependent care assistance programs (DCAPs). The IRS also provided increased flexibility with respect to grace periods to apply unused amounts in health FSAs to medical care expenses incurred through December 31, 2020, and unused amounts in DCAPs to dependent care expenses incurred through December 31, 2020. This relief is retroactive to January 1, 2020.

An employer that decides to amend one or more of its Code Sec. 125 cafeteria plans to provide for midyear election changes for employer-sponsored health coverage, health FSAs, or DCAPs or to provide for an extended period to apply unused amounts remaining in a health FSA or a DCAP to pay or reimburse medical care expenses or dependent care expenses in a manner consistent with this notice must adopt a plan amendment on or before December 31, 2021, and may be effective retroactively to January 1, 2020.

In Notice 2020-33, the IRS increased the carryover limit to $550 (from $500) of unused amounts remaining at the end of a plan year in a health FSA that may be carried over to pay or reimburse a participant for medical care expenses incurred during the following plan year. In addition, the notice clarifies the ability of an individual coverage health reimbursement arrangement (ICHRA) to reimburse individual policy premium expenses incurred prior to the beginning of the plan year for coverage provided during the plan year.

Midyear elections. Qualified benefits provided under a cafeteria plan include employer-provided accident and health plans excludable under Code Secs. 105(b) and 106, health FSAs excludable under Code Secs. 105(b) and 106, and DCAPs excludable under Code Sec. 129. Elections regarding these benefits are generally irrevocable and must be made prior to the first day of the plan year, except that a cafeteria plan may permit an employee to revoke an election during a period of coverage and to make a new election under certain circumstances, such as if the employee experiences a change in status or there are significant changes in the cost of coverage.

During 2020, a cafeteria plan also may permit eligible employees to: (1) with respect to employer-sponsored health coverage, (a) make a new election on a prospective basis, if the employee initially declined to elect employer-sponsored health coverage; (b) 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 (c) 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; (2) revoke an election, make a new election, or decrease or increase an existing election applicable to a health FSA on a prospective basis; and (3) revoke an election, make a new election, or decrease or increase an existing election regarding a DCAP on a prospective basis.

To accept an employee’s revocation of an existing election for employer-sponsored health coverage, the employer must receive from the employee an attestation in writing that the employee is enrolled, or immediately will enroll, in other comprehensive health coverage not sponsored by the employer. The employer may rely on the written attestation provided by the employee, 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.

This relief may be applied retroactively to periods on or after January 1, 2020.

Health FSAs and DCAPs. A cafeteria plan may permit the carryover of unused amounts remaining in a health FSA at the end of a plan year, subject to the carryover limit (currently $550 as updated by Notice 2020-33, see below). Additionally, a cafeteria plan may permit a grace period to apply unused amounts (including amounts remaining in a health FSA or DCAP) at the end of a plan year to pay expenses incurred for those same qualified benefits during the period of up to two months and 15 days immediately following the end of the plan year. For a health FSA, a cafeteria plan may adopt a carryover or a grace period (or neither), but may not adopt both.

For unused amounts remaining in a health FSA or a DCAP at the end of a grace period or plan year ending in 2020, a cafeteria plan may permit employees to apply those unused amounts to pay or reimburse medical care expenses or dependent care expenses incurred through December 31, 2020. For example, if an employer sponsors cafeteria plan with a health FSA that has a calendar year plan year and provides for a grace period ending on March 15 immediately following the end of each plan year, the employer may amend the plan to permit employees to apply unused amounts remaining in an employee’s health FSA as of March 15, 2020, to reimburse the employee for medical care expenses incurred through December 31, 2020.

This relief may be applied on or after January 1, 2020, and on or before December 31, 2020.

Health FSA reimbursements and HSA contributions. Code Sec. 223 permits eligible individuals to establish and contribute to health savings accounts (HSAs). An eligible individual is, with respect to any month, any individual if: (i) such individual is covered under an HDHP as of the first day of such month, and (ii) such individual is not, while covered under an HDHP, covered under any health plan which is not an HDHP, and which provides coverage for any benefit which is covered under the HDHP. An HDHP is a health plan that satisfies the minimum annual deductible requirement and maximum out-of-pocket expenses requirement under Code Sec. 223(c)(2)(A).

Coverage by a general purpose health FSA is coverage by a health plan that disqualifies an otherwise eligible individual from contributing to an HSA. Similarly, a telemedicine arrangement would generally disqualify an otherwise eligible individual from contributing to an HSA.

The relief has previously been provided for these issues. IRS Notice 2020-15 provides that a health plan that otherwise satisfies the requirements to be an HDHP will not fail to be an HDHP merely because the health plan provides medical care services and items purchased related to testing for and treatment of COVID-19. Likewise, Section 3701 of the CARES Act amends Code Sec. 223(c) of the Code to provide a temporary safe harbor for providing coverage for telehealth and other remote care services. Notice 2020-29 clarifies that this relief may be applied retroactively to January 1, 2020. For example, an otherwise eligible individual with coverage under an HDHP who also received coverage beginning February 15, 2020 for telehealth and other remote care services under an arrangement that is not an HDHP will not be disqualified from contributing to an HSA during 2020.

Increased carryover amount. Since 2013, the IRS has allowed health FSAs to offer a $500 carryover, in which participants can carry over unused amounts remaining at the end of a plan year in a health FSA (up to $500) to pay or reimburse a participant for medical care expenses incurred during the following plan year. Under Notice 2020-33, the IRS increases the $500 carryover amount for 2020 or later years to an amount equal to 20 percent of the maximum health FSA salary reduction contribution for that plan year. Therefore, for plan years beginning on or after 2020, the carryover amount is $550 (20 percent of $2,750).

Employers that want to offer the indexed increase in the health FSA carryover amount must adopt a plan amendment to the Sec. 125 cafeteria plan on or before the last day of the plan year from which amounts may be carried over. Therefore, employers sponsoring a calendar year plan must adopt the amendment allowing the indexed carryover limit no later than December 31, 2020.

ICHRAs. Notice 2020-33 also addresses individual coverage health reimbursement arrangements (ICHRAs). Specifically, the notice clarifies the ability of a health plan to reimburse individual insurance policy premium expenses incurred prior to the beginning of the plan year for coverage provided during the plan year.

The IRS provides that a plan is permitted to treat an expense for a premium for health insurance coverage as incurred on: (1) the first day of each month of coverage on a pro rata basis, (2) the first day of the period of coverage, or (3) the date the premium is paid. Thus, for example, an ICHRA with a calendar year plan year may immediately reimburse a substantiated premium for health insurance coverage that begins on January 1 of that plan year, even if the covered individual paid the premium for the coverage prior to the first day of the plan year.

SOURCE: Notice 2020-29, I.R.B. 2020-22, May 26, 2020; and Notice 2020-33, I.R.B. 2020-22, May 26, 2020.

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