The COVID-19 pandemic continues to wreak havoc, affecting lives not only on a personal level, but on a professional one. Employers at a minimum must be well versed in various new employment and labor issues as well as employee benefit matters which greatly affect their workforce.
Due to closure of schools and day cares throughout 2020, many dependent care flexible spending accounts (FSAs) remain overfunded, leaving numerous employees with the threat of forfeited account balances. Similarly, due to delay and cancellation of certain medical procedures, health FSA amounts were also unused. While the IRS relaxed Code section 125 change in election rules in May of 2020, many employees simply did not have enough claims to use up the funds in their FSA accounts, resulting in forfeiture risks.
However, Congress passed the Consolidated Appropriations Act, 2021 (“Act”) late December 2020, which further relaxes the otherwise strict election changes rules of Code section 125, allows carryovers of account balances, extends grace periods, and increases the dependent age for dependent care FSA qualifying expenses.
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, in May 2020, the IRS released IRS Notice 2020-29 which relaxed the Code section 125 rule requiring qualifying change in status events in order to make a mid-year change in election. With respect to FSAs, employers wanting to implement such changes could amend their plan documents in order to allow employees to revoke an election, make a new election, or decrease or increase an existing election applicable to a health or dependent care FSA on a prospective basis. These changes apply regardless of whether the basis for the election change meets the Treas. Reg. 1.125-4 requirements. Please note the term prospective. Employees could not retroactively change their elections.
This was a voluntary change and was only for the 2020 plan year.
Additionally, Notice 2020-29 provided flexibility and allowed employees to “spend down” their FSAs through December 31, 2020. As calendar year plans already allowed expenses to be incurred through December 31, 2020, this Notice did not provide relief in those circumstances. It instead applied to plans with grace periods that ended in 2020 or whose plan year ended in 2020. Upon amendment, participants in those plans could continue to incur eligible expenses through December 31, 2020 and submit requests for reimbursement consistent with plan terms.
This relief ended on December 31, 2020, and, aside from any already applicable grace periods, no relief was provided for employees who had unused FSA amounts after that date, which are subject to forfeiture.
Consolidated Appropriations Act, 2021
Relief is found in the newly passed Consolidated Appropriations Act, 2021.
This Act, in part, loosens certain rules associated with both health and dependent care FSAs. Specifically, upon amendment to appropriate plan documents, the Act allows for the following:
- Carryover to the 2021 Plan Year: This provision allows any unused benefits or contributions in FSAs from plan years ending in 2020 to be carried over to the plan year ending in 2021;
- The Act states the carryover must follow rules similar to the health FSA rules… however, while health FSA carryovers are subject to a $550 cap, the Act specifically states that any unused benefits or contributions may be carried over.
- Significantly, dependent care FSAs were not previously allowed to have a carryover provision.
- Carryover to the 2022 Plan Year: This provision allows any unused benefits or contributions in FSAs from plan years ending in 2021 to be carried over to the plan year ending in 2022;
- Again, the Act states the carryover must follow rules similar to the health FSA rules…
- This provision is important especially in situations involving the dependent care FSAs. These FSAs have a maximum reimbursement of $5,000 per calendar year. If an employee is allowed to carry over unused contributions into 2021 from 2020, but had also elected a full $5,000 for plan year 2021, s/he would have an overfunded account. This can be handled in one of two ways: (1) this additional carryover provision from 2021 to 2022, and/or (2) prospective election changes for FSAs for plan years ending in 2021 without regard to the strict status change rules (see last bullet below). With regard to the latter, employees can change their dependent care election for 2021 to prevent future contributions from being made.
- Grace Periods: For health or dependent care FSAs that have a grace period for plan years ending in 2020 or 2021, the grace period may be extended from the traditional two months and 15 days to a full 12 months after the end of such plan year in order for unused benefits or contributions to be utilized.
- Post-Termination Health FSA Reimbursements: Health FSAs are now allowed to continue to reimburse former participants for claims incurred post-termination similar to dependent care FSAs, namely:
- Employees who ceased participation in the plan during calendar years 2020 or 2021 may continue to receive reimbursements from unused benefits or contributions through the end of the plan year in which participation ceased.
- Dependent Care FSA Age Out Rule: In order for eligible employees to receive reimbursement for dependent care assistance, their dependent must be under the age of 13 when the expenses were incurred. However, for employees who were enrolled in the dependent care FSA (as long as the regular enrollment period was on or before January 31, 2020), age 14 is substituted for age 13 for the last plan year, and, if the employee had an unused balance in the FSA for such plan year, age 14 is also substituted for the subsequent plan year with respect to those unused amounts.
- Change in Election: Similar to the IRS Notice 2020-29, but for plan years ending in 2021, health and dependent care FSAs may allow employees to make mid-year election changes prospectively without regard to change in status rules.
To allow any of the above provisions, the cafeteria plan or arrangement including the FSAs must be amended to allow for such provisions 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 (so generally by December 31, 2022). The amendment may be retroactive as long as the plan is operated consistently with the terms of the amendment beginning its effective date.
Plan sponsors must determine whether they wish to proceed with any of the above provisions, largely in part depending on whether plan year 2020 would otherwise result in unprecedented forfeitures due to the pandemic. If so, they must communicate such provisions with their workforce and must administer the cafeteria plan or arrangement accordingly as of the amendment’s effective date, even if the amendment is adopted at a later date.
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 firstname.lastname@example.org.
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 email@example.com.