IRS Issues Increased Flexibility For Cafeteria Plans And FSAS
On May 12, 2020, the Internal Revenue Service (“IRS”) issued two notices which offer increased flexibility for employers with respect to Internal Revenue Code (“Code”) Section 125 cafeteria plans, health flexible spending accounts (“health FSAs”), and dependent care flexible spending accounts (“dependent care FSAs”).
Notice 2020-29. In light of the COVID-19 pandemic, this Notice provides increased flexibility for certain mid-year election changes in cafeteria plans and extends the “use-it-or-lose-it” period for amounts remaining in a health FSA or dependent care FSA.
- Flexibility for Mid-Year Elections. Generally, participant elections under Code Section 125 cafeteria plans and FSAs are irrevocable and must be made before the start of a plan year (subject to very limited exceptions). But under Notice 2020-29, the IRS permits cafeteria plans to allow employees eligible for the cafeteria plan to make the following prospective mid-year election changes during the 2020 calendar year:
- Make a new election, if the employee initially declined coverage;
- Revoke an existing election and make a new election to enroll in different coverage sponsored by the employer (including changing from self-only coverage to family coverage); and
- Revoke an existing election and attest in writing that the employee is enrolled or will enroll in other health coverage not sponsored by the employer. The Notice includes an example of an acceptable written attestation for such purpose.
The Notice also permits employers to allow participants in a health FSA or dependent care FSA to revoke an election, make a new election, or decrease or increase an existing election on a prospective basis.
Important note: the flexibility on mid-year elections does not extend or apply to the underlying plan. If an employer’s group health plan is fully insured, the insurer would not be bound by mid-year election changes if not permitted under the policy of insurance.
- Relaxation of the Use-it-or-Lose-it Rule for FSA Claims. Under prior rules, an employee’s unused balance remaining in a health FSA or dependent care FSA at the end of the plan year must be forfeited unless the plan permits either a carryover (limited to $500), or a grace period (under which a participant may apply the unused balance to pay expenses incurred in the first 2 months and 15 days of the subsequent plan year). But under Notice 2020-29, the IRS extends the period of time that a participant may incur and file claims during an FSA’s grace period to December 31, 2020, for grace periods ending in 2020. The Notice also permits employers to extend the time period during which a participant may use the carryover amount.
This temporary relief is completely optional, but any plan sponsors wanting to take advantage of the increased flexibility should note that their plans must be amended no later than December 31, 2021.
Notice 2020-33. As noted above, under current guidance, an employer may allow a health FSA to provide for a $500 carryover. Notice 2020-33 increases the maximum $500 carryover amount for a plan year to an amount equal to 20% of the maximum health FSA salary reduction contribution for that plan year. For 2020, the maximum contribution amount is $2,750, so under this new guidance, the maximum amount permitted to be carried over from 2020 to 2021 is $550 (20% of $2,750). Employers must amend their plans to take advantage of this updated calculation of the maximum carryover amount.
Notice 2020-33 is not related to COVID-19 and therefore does not contain an expiration date, but employers wishing to take advantage of both this increased maximum carryover amount and the increased flexibility offered in Notice 2020-29 may avoid having to amend their plans twice, thanks to the convenient timing of the Notices.