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Client Alert: IRS Relaxes Section 125 Mid-Year Change Rules & Increases Health FSA Carryovers

In two recently released Notices, the Internal Revenue Service (IRS) relaxes the irrevocability rule under Internal Revenue Code section 125 relating to cafeteria plans, increases carryover allowances for health flexible spending accounts (health FSAs), extends the period of time to […]

In two recently released Notices, the Internal Revenue Service (IRS) relaxes the irrevocability rule under Internal Revenue Code section 125 relating to cafeteria plans, increases carryover allowances for health flexible spending accounts (health FSAs), extends the period of time to “spend down” unused health FSA and dependent care FSA amounts, and expands previous guidance to provide that certain covered services will not affect high deductible health plan (HDHP) status… retroactive to January 1, 2020.


IRS Notice 2020-33 

IRS Notice 2020-29 

Section 125 Plan participants have found themselves in difficult situations as they had elected certain health and dependent care FSA amounts to use during 2020 only to find that certain medical procedures were delayed or canceled and that day care facilities were closed due to COVID-19. Moreover, group health plans are changing based on certain new coverage requirements, incomes are dropping, and layoffs are occurring. Employees are finding themselves in a position where they can no longer afford such coverage; however, IRS procedures in many of these situations would not support mid-year election changes. These are just a few examples of election issues currently occurring.

The IRS, therefore, is relaxing the typical rigid Section 125 rules. However, in order to take advantage of this leniency, employers must amend their Section 125 cafeteria plans.

Section 125 Irrevocability Rules Relaxed

Once an election is made under a Section 125 cafeteria plan, that election is irrevocable for the entire plan year, unless (1) one of the mid-year qualifying change in election events occurs as set forth in Treas. Reg. 1.125-4; and (2) the employer’s cafeteria plan incorporates the mid-year change rule.

However, IRS Notice 2020-29 relaxes these rules during calendar year 2020 relating to employer-sponsored health coverage, health FSAs, and dependent care FSAs, and the relief may be applied retroactively to periods on or after January 1, 2020.  These changes apply regardless of whether the basis for the election change meets the Treas. Reg. 1.125-4 requirements. A plan amendment is required.  

Specifically, Notice 2020-29 provides as follows:

  • For mid-year elections made during calendar year 2020, a section 125 cafeteria plan may permit employees who are eligible to make salary reduction contributions under the plan to:
    • with respect to employer-sponsored health coverage, 
      • 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, including changing from self-only to family coverage; 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; sample attestation language is provided in the Notice;
    • revoke an election, make a new election, or decrease or increase an existing election applicable to a health FSA on a prospective basis; and 
    • revoke an election, make a new election, or decrease or increase an existing election regarding a dependent care FSA on a prospective basis.

An employer does not need to adopt these more lenient rules and can continue with its current plan procedures. However, given that they could help a number of employees, it is something to consider.

Increase in Carryovers to Health FSAs

If an employer’s cafeteria plan has a health FSA with a carryover provision, another allowable change is permitted. IRS Notice 2020-33 allows, upon plan amendment, for the 2020 plan year carryover to be increased to $550. Previously, only a $500 carryover was allowed. And if the plan is amended correctly, the $550 will likely increase in future years. Please note that this is not for any plan years which started in 2019 and ended in 2020… that carryover remains $500.  

Specifically, IRS Notice 2020-33 increases the maximum carryover amount for plan years starting in 2020 to an amount equal to 20% of the maximum Section 125(i) salary reduction contribution for that plan year. Therefore, the maximum amount allowed to be carried over from a plan year starting in 2020 to the immediately following plan year beginning in 2021 is $550 (20% of $2,750). A plan amendment must be made on or before the last day of the plan year that adopts the carryover increase; however, a special amendment timing rule exists for the 2020 plan year under Notice 2020-29.

Moreover, for the remainder of 2020, employees are permitted to change their elections mid-year in order to increase their health FSA (including an initial election to fund a health FSA) due to the increased carryover under Notice 2020-29.  However, these changes must be applied prospectively only. 

Significantly, Notice 2020-33 provides as follows:

  • Although only future salary may be reduced under the revised election, 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.

An amendment must be made on or before December 31, 2021 and may be effective retroactively to January 1, 2020 (or the first day of the plan year in 2020 if later), provided that the employer informs all eligible individuals of the changes to the plan.

Extended Period to Spend Down FSAs

Many employees had elected amounts in dependent care and health FSAs and were (or are) unable to use them due to reasons such as closed day care facilities or canceled medical procedures.  Under the strict Code section 125, unused amounts in these accounts are forfeited at the end of the Plan Year, subject to any carryover provisions (applicable to health FSAs only) or grace periods.

Here, Notice 2020-29 provides flexibility and allows employees to “spend down” their accounts through December 31, 2020. As calendar year plans already allow expenses to be incurred through December 31, 2020, this Notice does not provide relief. It instead applies to plans with grace periods that end in 2020 or whose plan year ends in 2020. Upon amendment, participants in those plans may continue to incur eligible expenses through December 31, 2020 and submit requests for reimbursement consistent with plan terms.

Specifically, the Notice provides:

  • For unused amounts remaining in a health FSA or a dependent care assistance program under the section 125 cafeteria plan as of the end of a grace period or plan year ending in 2020, a section 125 cafeteria plan may permit employees to apply those unused amounts to pay or reimburse medical care expenses or dependent care expenses, respectively, incurred through December 31, 2020.

Please see below for one of the examples listed in the Notice:

Example 1. Employer provides a health FSA under a § 125 cafeteria plan that allows a $500 carryover for the 2019 plan year (July 1, 2019 to June 30, 2020). Pursuant to this notice and Notice 2020-33, Employer amends the plan to adopt a $550 (indexed) carryover beginning with the 2020 plan year, and also amends the plan to adopt the temporary extended period for incurring claims with respect to the 2019 plan year, allowing for claims incurred prior to January 1, 2021, to be paid with respect to amounts from the 2019 plan year. 

Employee A has a remaining balance in his health FSA for the 2019 plan year of $2,000 on June 30, 2020, because a scheduled non-emergency procedure was postponed. For the 2020 plan year beginning July 1, 2020, Employee A elects to contribute $2,000 to his health FSA. Employee A is able to reschedule the procedure before December 31, 2020 and, between July 1, 2020 and December 31, 2020, incurs $1,900 in medical care expenses. The health FSA may reimburse Employee A $1,900 from the $2,000 remaining in his health FSA at the end of the 2019 plan year, leaving $100 unused from the 2019 plan year. Under the plan terms that provide for a carryover, Employee A is allowed to use the remaining $100 in his health FSA until June 30, 2021, to reimburse claims incurred during the 2020 plan year. Employee A may be reimbursed for up to $2,100 ($2,000 contributed to the health FSA for the 2020 plan year plus $100 carryover from the 2019 plan year) for medical care expenses incurred between January 1, 2021 and June 30, 2021. In addition, Employee A may carry over to the 2021 plan year beginning July 1, 2021 up to $550 of any remaining portion of that $2,100 after claims are processed for the 2020 plan year that began July 1, 2020. A grace period is not available for the plan year ending June 30, 2021. 

Again, plan amendments will be required to accomplish the above and must be adopted on or before December 31, 2021. The amendment may be effective retroactively to January 1, 2020 as long as the above Notices are followed and the employees are informed.

Status of HDHPs

Last, the IRS extends certain previous relief for HDHPs retroactively, back to January 1, 2020.  Specifically, Notice 2020-29 separately expands Notice 2020-15 to provide that reimbursement of expenses for testing and treatment of COVID-19 incurred on or after January 1, 2020 will not result in an HDHP to fail to be an HDHP under Code section 223. Additionally, testing and treatment for COVID-19 includes “the panel of diagnostic testing for influenza A & B, norovirus and other coronaviruses, and respiratory syncytial virus (RSV) and any items or services required to be covered with zero cost sharing under … the CARES Act.”  

Moreover, telehealth and other remote care services provided on or after January 1, 2020 (applying only for plan years beginning on or before December 31, 2021) will not affect HDHP status.  The CARES Act previously applied only for services incurred on or after March 27, 2020.


As always, consultation is important to determine if these changes will be of benefit to employers and their employees. Many factors should be considered, such as nondiscrimination rules, adverse selection with allowing mid-year changes, whether extending health FSA reimbursement provisions will negatively affect health savings accounts, and additional required employee communications.

As you are well aware, the law and guidance are rapidly evolving in this area. Please check with your Fraser Trebilcock attorney for the most recent updates.

This alert serves as a general summary, and does not constitute legal guidance. Please contact us with any specific questions.

We have created a response team to the rapidly changing COVID-19 situation and the law and guidance that follows, so we will continue to post any new developments. You can view our COVID-19 Response Page and additional resources by following the link here. In the meantime, if you have any questions, please contact your Fraser Trebilcock attorney.

Elizabeth H. Latchana specializes in employee health and welfare benefits. Recognized for her outstanding legal work, in both 2019 and 2015, Beth was selected as “Lawyer of the Year” in Lansing for Employee Benefits (ERISA) Law by Best Lawyers, and in 2017 as one of the Top 30 “Women in the Law” by Michigan Lawyers Weekly. Contact her for more information on this reminder or other matters at 517.377.0826 or

Brian T. Gallagher is an attorney at Fraser Trebilcock specializing in ERISA, Employee Benefits, and Deferred and Executive Compensation. He can be reached at (517) 377-0886 or