IRS Clarifies FSA Relief in CAA, Provides More Flexibility for Cafeteria Plan Elections
On February 18th, the IRS issued Notice 2021-15 to explain the temporary health flexible spending account (FSA) and dependent care FSA (i.e., a dependent care assistance program (DCAP)) relief in the Consolidated Appropriations Act (CAA) and to build upon temporary election change relief for other pre-tax benefits from last year’s Notice 2020-29, among other changes.
Specifically, the IRS Notice clarified the following areas of the CAA:
- CAA Carryovers. All health FSAs and DCAPs may adopt an uncapped carryover – the entire amount that a participant elected to contribute for the prior plan year – for plan years ending in 2020 and 2021, even if they currently have a grace period (but may not have both a carryover and grace period for the same plan year). An employer may require a minimum election amount for the current plan year to be eligible for the carryover. An employer also may, if they want, limit the carryover amount or limit the carryover period to less than 12 months. A carryover in a general purpose health FSA makes the individual HSA ineligible, although an employer may allow employees to waive the carryover amount or an employer may automatically convert the balance to an HSA-compatible health FSA (i.e., a limited purpose or post-deductible health FSA). Employers may also amend their plans to allow an employee-by-employee choice, including as part of a mid-year election, between an HSA-compatible health FSA or a general purpose health FSA, but only during the temporary relief period.
- CAA Carryover Limits. Health FSAs with the carryover may permit participants to elect the full $2,750 for the 2021 plan year, all on a pre-tax basis. Similarly, DCAPs with the carryover may reimburse up to $5,000 in expenses ($2,500 if married filing separately) for the 2021 plan year and reimburse expenses from the carryover, all on a tax-free basis (as confirmed informally by IRS representatives). W-2 reporting in Box 10 should reflect only current year DCAP contributions, without regard to carryover or grace period amounts.
- CAA Grace Periods. IRS previously extended the grace period available for health FSAs and DCAPs to the end of calendar year 2020 in Notice 2020-29. The CAA extends grace periods for the 2020 and 2021 plan years to 12 months after the end of the applicable plan year. An employer that didn’t have a grace period attached to its 2020 plan year could still adopt one, if the plan has been operated as though it had a 2020 grace period from the start of the 2021 plan year.
- CAA Health FSA Spend-Downs. As with a DCAP, an employer may during the 2020 and 2021 plan years allow employees who cease health FSA participation to spend down their balance by incurring claims during an extended period up to the end of the current plan year, including any applicable grace period. Employers may want to add this option to provide relief to employees who have account balances, but cease participation in the health FSA because they terminate employment, change employment status, or make a new election during the plan year. Employers may limit the time period for the spend-down. They may also limit the amount so that the available balance does not exceed current plan year contributions less reimbursements. A general purpose health FSA spend-down period will make a participant ineligible for HSA contributions during that period.
- COBRA for health FSAs. Even if an employer adopts the extended period for spend-downs, the termination of coverage resulting from a termination of employment or reduction in hours will still be subject to the limited COBRA obligation. The carryover and grace period relief does not affect the COBRA applicable premium, which is based on the current plan year election. The carryover and grace period balances must be available to COBRA qualified beneficiaries on the same basis as active employees.
- DCAP Special Age Limit. This relief allows employees with children who turned age 13 in the 2020 or 2021 plan year to be reimbursed for their expenses from the 2020 plan year balance (including carryover or grace period). In order to take advantage of this provision, the enrollment period for the DCAP with the unused funds must have been on or before January 31, 2020.
The CAA allowed health FSA and DCAP election changes without a qualifying reason for the 2021 calendar year, including options for employees who hadn’t made an election for the health FSA or DCAP for 2021. In this most recent notice, the IRS broadened the relief to mirror Notice 2020-29 so that an employer may allow election changes for all pre-tax health benefits in the 2021 plan year without a qualifying reason. The rules retain the written attestation requirement of other coverage for revoking medical coverage. Interestingly, while the election must be prospective, amounts contributed to a health FSA or DCAP after the revised election can be used for any medical care expense or dependent care expense, respectively, incurred during the first plan year that begins on or after January 1, 2021, through the end of the 2021 plan year.
All of the above relief is at the employer’s discretion. Next steps should include working with the FSA vendor and developing plan amendments.
A detailed GRIST analysis will soon be available on Mercer’s Law & Policy Group – Our Thinking page.