The Internal Revenue Service issued guidance allowing temporary changes to cafeteria plan rules resulting from the COVID-19 pandemic. The guidance increases the ability to make mid-year election changes under a cafeteria plan; extends the claim incurred period for health care and dependent day care flexible spending account plans for certain plans; and increases the carryover amount to $550. These changes are set forth in IRS Notice 2020-29 and IRS Notice 2020-33.
A Code section 125 Plan (“cafeteria plan”) allows participants to use pre-tax dollars to pay for certain health benefits offered by the employer. As a condition of receiving benefits on a tax-favored basis, the IRS requires employees’ cafeteria plan elections to be locked-in for the entire plan year with changes allowed in only limited approved circumstances. As a condition of a flexible spending account plan receiving tax-favored treatment, the IRS requires participants to forfeit amounts not used by the end of the plan year (and grace period, if applicable). There is a limited exception to the “use-it-or-lose-it” rule for health FSAs that allows a $500 carryover to the next plan year.
The government recognizes that the COVID-19 pandemic creates unanticipated changes in the need for medical care and dependent day care coverage. Employees who initially declined employer-offered health coverage may now wish to enroll or make changes to their elected coverage. Health flexible spending account plan participants may want to increase or decrease their pre-tax annual elections for either not being able to incur expected expenses or having additional unexpected expenses due to COVID-19. Participants in a dependent day care flexible spending account plan may no longer need day care or may have increased day care expenses due to changed work conditions. The existing cafeteria plan mid-year change rules do not address the new situations brought on by COVID-19.
Notices 2020-29 and 2020-33 are the government’s response to these challenges. The Notices allow employers to recognize more cafeteria plan change events and provide an increased time period for incurring FSA claims. The guidance provided in the new Notices is permissible (not required) and applies to all participants, not just those with an COVID-19 event. Plan sponsors who wish to implement any of the new options are advised to amend their plan documents accordingly.
Expansion of Mid-Year Election Changes
The permissible mid-year election events are expanded to include the following for calendar year 2020. All changes must be approved on a prospective basis, only.
- With respect to employer-sponsored health coverage, an employee may
- Make a new election if the employee initially declined the employer’s offer of health coverage;
- Revoke an existing health plan election and enroll in different coverage; or
- Revoke an existing election of coverage if the employee attests in writing that the employee is enrolled or will enroll immediately in other health coverage not sponsored by the employer (the guidance provides suggested wording that would be considered an acceptable written attestation)
- With respect to health flexible spending account plan participation, an employee may
- Revoke an election,
- Make a new election, or
- Decrease/increase an existing election
- With respect to dependent day care flexible spending account plan participation, an employee may
- Revoke an election,
- Make a new election, or
- Decrease/increase an existing election
An employer taking advantage of the mid-year election change expansion is not required to provide unlimited election changes and may instead implement only the permissive changes as it desires. The IRS warns employers that they cannot implement the new options in a discriminatory manner and may wish to consider the potential for employees’ adverse selection of health coverage if new mid-year change events are offered.
Extended Claims Period for Health Care and Dependent Day Care FSAs
The guidance allows FSAs to offer participants an extended time to use funds that would otherwise be forfeited.
A plan may allow employees to apply unused amounts remaining in a health care or dependent day care FSA at the end of a grace period or plan year ending in 2020 to reimburse eligible medical/dependent care expenses incurred through December 31, 2020. This relief applies to all health FSAs, including limited purpose health FSAs.
For example, if an employer sponsors a calendar year health FSA that has a grace period ending March 15, 2020, the employer may amend the plan to allow employees to apply unused amounts remaining in the 2019 health FSA at the end of the grace period to reimburse eligible medical expenses incurred through December 31, 2020. Expenses incurred through the end of December 31, 2020 can first be used toward remaining 2019 amounts before being applied to 2020 contributions.
Similarly, an employer with a 7/1 plan year may amend the plan to allow employees to apply unused amounts remaining in the 2019 health FSA as of June 30, 2020 to reimburse eligible medical expenses incurred through December 31, 2020. Once again, expenses will first be used toward reducing remaining 2019 amounts before being applied to 2020 contributions.
Carryover Amount Increase
The IRS increased the limit for unused health FSA carryover amounts to $550.
The health care FSA rules prohibit participants from using contributions made in one plan year to purchase benefits provided in a subsequent plan year. In 2013, the use-it-or-lose-it rule was loosened to allow up to $500 of unused amounts to be carried over for use in the next plan year (“permissible carryover”). The amount which may be carried over is equal to the lesser of (1) any unused amounts from the immediately preceding plan year or (2) up to $500. The $500 dollar amount is now increased to $550 for 2020 and later plan years.
If an employer allows, individuals who, during 2020, wish to increase their health FSA contributions, or begin to make health FSA contributions, as a result of the increased carryover amount may be allowed do so in accordance with the new mid-year change rules. Only future salary may be reduced under the revised election, but amounts contributed to the health FSA after the revised election may be used for any medical care expense incurred during the first plan year that begins on or after January 1, 2020.
Plan Amendments
The IRS warns that employers deciding to implement any of the new permissible changes must adopt a plan amendment to do so. For the mid-year change events and extended FSA claims period, an amendment for the 2020 plan year must be adopted on or before December 31, 2021 and may be effective retroactively to January 1, 2020, provided the plan is operated in accordance with the Notice and employees are informed of the changes.
An amendment to adopt an increased carryover amount must be adopted on or before the last day of the plan year from which amounts may be carried over and may be effective retroactively to the first day of that plan year, once again provided the plan operates in accordance with the Notice and employees are informed about the carryover provision.
Employer Action
Employers should understand the new relaxed cafeteria plan guidance and consider if it is appropriate to implement any of the newly allowed changes. Plan documents and amendment processes should be reviewed to make sure changes are documented in accordance with company practice and plan requirements.
The Notices may be accessed by clicking here.
Notice 2020-29
Notice 2020-33
