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February 22, 2021
This week, the IRS released guidance further clarifying items in the recently passed Consolidated Appropriations Act of 2021 (CAA) permitting flexibility for health flexible spending arrangements (FSAs), dependent care account plans (DCAPs) and cafeteria plan election change rules. None of these changes are required. Employers have the option to implement some or all of the changes, or employers could choose not to change their plans at all. For employers who are willing to allow some additional flexibility, IRS Notice 2021-15 provides further details on exactly what is permitted and how it may impact things such as annual contribution limits, HSA-eligibility, COBRA continuation, and nondiscrimination rules. The notice also added some additional election change flexibility around health coverage similar to what was available in 2020 under Notice 2020-29.
IRS Notice 2021-15: www.irs.gov/pub/irs-drop/n-21-15.pdf
For plan years ending in 2020 or 2021, an employer may choose to adopt the following:
A health FSA or DCAP may offer a carryover or an extended grace period, but not both. While both options may offer the ability for participants to use the prior year’s unused balance into the next plan year, a grace period will make the unused balance available to those who are no longer participants, while a carryover is generally only available to those who are still participating in the subsequent plan year.
The expanded carryover or extended grace period is allowed for limited-purpose, post-deductible, and general-purpose health FSAs. For health FSAs and DCAPs, the carryover or grace period may be offered regardless of whether the plan is currently designed to offer a carryover, grace period, or neither one. So, for example, a health FSA that currently offers a carryover could be amended to instead offer an extended grace period, and a DCAP that currently offers a 2 ½ month grace period could be amended to instead offer a carryover.
An employer adopting either the expanded carryover or extended grace period has some flexibility with the design. For instance, the employer could limit the amount of the carryover, or offer a grace period of less than 12 months. The employer could also limit the ability to carryover unused amounts to those who elect to contribute toward the next plan year.
Unused amounts carried over from prior years or available during an extended grace period are not taken into account for purposes of determining the annual contribution limits. Therefore, for the 2021 plan year, participants may elect to contribute up to $2,750 into a health FSA even if they have a carryover or extended grace period available from unused amounts contributed during the 2020 plan year. Similarly, participants may contribute up to $5,000 to a DCAP in addition to any carryover or extended grace period amounts that may be available from the previous plan year. In addition, unused amounts from a plan year ending in 2020 that are not used during 2021 could be made available into the 2022 plan year.
When considering whether and how to adopt a carryover or extended grace period for the health FSA, the employer should consider HSA-eligibility. Individuals who are eligible for reimbursement from a general-purpose health FSA are not eligible to contribute to an HSA. For participants with a health FSA balance at the end of the plan year, a carryover or extended grace period could extend HSA-ineligibility into the next plan year.
Finally, amounts available via a carryover or extended grace period are disregarded in determining the COBRA premium for a health FSA, and can be ignored for purposes of §125 and §129 discrimination testing.
For employees who lose eligibility for a health FSA due to a reduction in hours or termination of employment during calendar year 2020 or 2021, the health FSA can continue to reimburse qualifying medical expenses incurred though the end of the plan year rather than being limited to reimbursement of expenses incurred prior to the loss of eligibility. Employers considering this option will generally want to limit the reimbursement to contributions made prior to the loss of eligibility rather than allowing access to the full amount elected for the plan year. Adopting this flexibility does not relieve the employer of having to offer the option to elect COBRA continuation through the end of the health FSA plan year for an underspent account.
Typically, a DCAP can only be used to reimburse expenses related to dependents who have not attained the age of 13. The legislation contains a temporary rule that allows a plan to reimburse expenses for dependents who have not attained age 14 under the following circumstances:
Example: A DCAP with a plan year of January 1 – December 31, 2020 had an open enrollment period that ended November 30, 2019 (before January 31, 2020). Employee elected $5,000 for the 2020 plan year, and the employee’s dependent child turned 13 in September 2020. Employee may use the $5,000 for any qualifying daycare expenses for the child incurred during 2020; and any balance remaining at the end of the 2020 plan year may be used to reimburse qualifying expenses for the 13-year-old until September 2021 (when the child turns 14).
For any plan years ending during 2021, the employer may permit participants to make the following mid-year election changes, on a prospective basis, even without a recognized change in statue event:
NOTE: The CAA provided flexibility to make prospective health FSA or DCAP election changes. The ability to allow participants to make election changes to health coverage is new under this IRS guidance (although it was permitted during 2020 under IRS Notice 2020-29). Permitting previously waived employees to elect coverage mid-year does needs to be approved by the insurance carrier or stop loss before amending the plan.
An employer choosing to adopt some flexibility for election changes is permitted to limit the number of election changes and the time frame for making election changes, but any permitted election must be allowed only on a prospective basis. Employers may want to allow employees to change elections from a higher cost option to a lower cost plan, but not allow new enrollments for employees who previously waived coverage (unless required by existing HIPAA special enrollment requirements). For health FSAs and DCAPs:
Plans may be amended retroactively to implement any or all of these provisions so long as the employer operates in accordance with the terms of the amendment and informs all employees eligible to participate in the cafeteria plan of the changes to the plan. The plan amendment must be made no later than the last day of the first calendar year beginning after the end of the plan year in which the amendment is effective. For example, for changes made to plan with a plan year ending 12/31/2020, the amendment must be made by 12/31/2021; and an amendment for a 2020 non-calendar year plan, must be adopted by December 31, 2022. Employers may adopt a plan amendment by indicating that the amendment supersedes normal operations for the applicable plan years to allow the plan to revert to previous practice (e.g. a carryover up to $550 or a 2 ½ month grace period) without further amendment.
The changes available via the CAA and further clarified in IRS Notice 2021-15 are completely optional, and employers choosing to adopt some of the permitted changes have significant of flexibility to place limits on such changes. For example, employers may want to allow some of the changes for its plan year ending during 2020, but not for the plan year ending in 2021. The changes will be welcomed by employees with significant year-end balances or those needing to make mid-year election changes, but employers will need to weigh this against the administrative and communication challenges that may accompany such changes. Employers will also need to closely coordinate with the vendors they use for plan administration.
The views and opinions expressed within are those of the author(s) and do not necessarily reflect the official policy or position of Parker, Smith & Feek. While every effort has been taken in compiling this information to ensure that its contents are totally accurate, neither the publisher nor the author can accept liability for any inaccuracies or changed circumstances of any information herein or for the consequences of any reliance placed upon it.