The IRS issued a notice that addresses many of the questions employers have raised about flexible spending accounts (FSAs) in view of the new rules set forth in the Consolidated Appropriations Act (CAA).
The CAA provides temporary relief for concerns raised by the COVID-19 pandemic by allowing: 1. temporary expansions of the opportunity to carry forward unused FSA contributions or to apply those unused contributions to expenses during a grace period in the following year; 2. the reimbursement of dependent care expenses for children who reach age 13 in certain instances; and 3. certain mid-year changes in FSA elections without a triggering event.
The new rules generally provide ease and comfort to employers that are considering implementation of these changes and offer guidance on some other issues as well.
Carryforwards and Grace Periods
The IRS notice offers particularly useful guidance on the two-year expansion of the carry forward rules to apply to all unused contributions and the two-year expansion of the grace period to allow the grace period to last 12 months in duration. For example, the new rules clarify that:
- Employers that have carryforward or grace period provisions may extend them. Those that do not may add them. Employers may expand the amount of carryforwards and length of grace periods but still limit them to less than the maximum that the CAA permits.
- To allow employees to be eligible to participate in a health savings account, an employer may allow them to opt out of a health FSA carryover or grace period provision. An employer may also allow an employee to switch from a general purpose health FSA to a limited purpose health FSA and, for any months where the employee has coverage only under a high deductible health plan and the HSA-compatible FSA, make or receive HSA contributions.
- The offer as to carryovers and grace periods does not need to be the same for all employees, but employers need to be mindful of applicable nondiscrimination requirements.
- Amounts carried forward into a new plan year or available in the new year because of a grace period will not be taken into account for nondiscrimination testing purposes in the new plan year.
- The maximum dollar limits for FSAs will apply to the amount contributed for a year. An employer may complete Form W-2 based on the amount that the employee has contributed for the year, without regard to whether the amounts are used. Amounts that are unused may result in some adjustments for individuals in their individual tax return for reporting dependent care assistance (Form 2441). That form ultimately looks toward when expenses are incurred for which dependent care assistance is received, which may provide an additional reason for employers to allow for a mid-year enrollment period.
An employer must still choose between offering a carryforward or grace period. It may provide one or the other (or neither) in an FSA. It cannot provide both.
Dependent Care FSA Reimbursements for Children who Turn 13
Although simply reflective of the CAA rules, the new guidance includes illustrative examples that can be helpful in understanding the temporary rules that allow for the reimbursement of dependent care expenses for children who reach age 13 (which is the usual cut-off age for dependent care assistance) in the 2020 or 2021 plan year.
For plan years that end in 2021, employers may permit employees to make mid-year changes to their health FSA elections without any change in status or other event to justify the change. Employees may newly elect to participate or may revise or revoke an existing election. Employers may make choices about the mid-year election, for example, selecting a particular period for elections or limiting the elections that can be made. Although the changes in contributions must be prospective, amounts contributed can be applied retroactively to reimburse for expenses incurred earlier in the plan year. Employers may also set rules for how account balances will be treated if an employee revokes an election to contribute.
The guidance addresses how certain mid-year changes will affect participation in a health savings account.
The new guidance also opens up health coverage (not only health FSA coverage) to mid-year changes in 2021 in a manner similar to guidance that applied in 2020. Employers may offer employees a mid-2021 opportunity to prospectively enroll in health coverage, change elections, or revoke coverage. Revocation is permitted only where the employee attests that he or she has or will immediately obtain health coverage elsewhere. A model attestation is provided.
An employee whose participation in a health FSA terminates mid-year may exhaust any remaining balance in his or her account through the reimbursement of post-termination expenses that are incurred later in the same plan year or during any applicable grace period for that plan year.
If an employee’s termination in a health FSA results from a qualifying event under COBRA, such as a termination of employment, the employee would have COBRA rights even if the plan allows the employee to exhaust his or her account through expenses incurred after the event. The employer would still be required to provide the employee with COBRA notice, although the incentive to elect COBRA may be significantly reduced. A COBRA premium may not take into account any unused amount from prior contributions.
Retroactive Amendment. For a calendar year plan, where changes became effective in 2020, amendments must be adopted by December 31, 2021. For non-calendar year plans, the deadline for adopting amendments may extend to December 31, 2022. In either case, the changes can apply retroactively as long as the FSAs have been administered in accordance with the new rules.
This same retroactive amendment period applies for health FSAs (and health reimbursement accounts) that are expanding coverage to include products that became newly available for reimbursement under the CARES Act—specifically, over-the-counter medication and menstrual products.
The new guidance will be welcomed by employers contemplating temporary changes to their FSAs. Although most of the guidance will not extend past the 2021 plan year, it will be interesting to see if any of the rules not specifically tied to issues created by the pandemic become accepted on an ongoing basis.