The Internal Revenue Service (“IRS”) has issued new guidance, Notice 2020-33, that increases the maximum carryover limit for health flexible spending arrangements (“health FSAs”), and clarifies the ability of health plans to reimburse premium expenses incurred prior to the beginning of the plan year.

Increased Carryover Limit

Health FSAs generally operate on a use-it-or-lose-it basis. Contributions for a year may be used to reimburse expenses incurred in that year. Any amounts remaining are forfeited. However, there are a couple of exceptions, including an exception that permits employees to carry over up to $500 in unused health FSA contributions to the next year, without reducing the amount of contributions in the next year.

The new guidance allows for the indexing of the maximum amount that may be carried over. The amount will now be set at 20 percent of the maximum amount of pre-tax employee contributions. That amount was originally $2,500, but has increased to $2,750 with inflation. As a result the maximum carryover limit is now increased from $500 to $550 for 2020. Thus, for a calendar year health FSA, the maximum amount that may be carried over to 2021 is $550. In future years, this increase will be rounded to the next lowest multiple of $10.

To allow for the increased carryover, an employer will need to amend its health FSA plan document. Under a special rule, a plan amendment made on or before December 31, 2021 can be effective for a carryover from a plan year that began January 1, 2020, as long as appropriate notice of the carryover is provided of the amount being carried over into 2021.

Timing of Reimbursements

Generally, health plan reimbursements must be made for expenses that are incurred in the applicable plan year. But premiums for health insurance for the first month of a new plan year may be paid from salary reductions contributed during the last month of the prior plan year. The new guidance allows for premium payments to continue to qualify for the exclusion from income, even if they are paid prior to the beginning of the year. This technical change applies to all health plans that pay for health plan premiums, including individual coverage health reimbursement arrangements. This guidance is in line with guidance that already applies for qualified small employer health reimbursement arrangements.

Ballard Spahr LLP’s Employee Benefits and Executive Compensation attorneys can counsel plan sponsors in making plan amendments and other plan design changes in accordance with the rapidly changing legal requirements.

As the federal health care reform effort gained steam, Ballard Spahr attorneys established the Health Care Reform Initiative to monitor and analyze legislative developments. With federal health care reform now a reality, our attorneys are assisting health care entities and employers in understanding the relevant changes and planning for the future. They also have launched the Health Care Reform Dashboard, an online resource center for news and analysis on developments under the Affordable Care Act.

If you have any questions, please contact G’Nece Jones at 215.864.8286, jonesgn@ballardspahr.com or Edward I. Leeds at 215.864.8419, leeds@ballardspahr.com.