On Feb. 18, 2021, the IRS released Notice 2021-15 to clarify the application of temporary special rules for health flexible spending arrangements (FSAs) and dependent care assistance programs (DCAPs) provided under the Consolidated Appropriations Act, 2021 (CAA).
The Notice responds to unanticipated changes in the availability of certain medical and dependent care as a result of COVID-19, as employees are more likely to have unused health FSA or DCAP amounts at the end of 2020 and 2021.
While the Notice also provides additional mid-year election change relief for Section 125 cafeteria plans generally, this Compliance Bulletin highlights the major clarifications and examples regarding the health FSA and DCAP relief. It also illustrates how the health FSA and DCAP relief provisions interact with each other, how certain provisions impact eligibility to contribute to an HSA as well as their impact on COBRA continuation coverage.
The CAA allows an employer, in its discretion, to provide a carryover of unused amounts remaining in a health FSA or DCAP as of the end of a plan year ending in 2020 or 2021 to the immediately subsequent year. The Notice clarifies that:
Impact on Eligibility to Contribute to an HSA
Under existing rules, coverage by a general-purpose health FSA disqualifies an otherwise eligible individual from contributing to an HSA, whereas coverage by an HSA-compatible health FSA (such as a limited-purpose or post-deductible health FSA) does not do so.
The Notice provides that:
Notwithstanding the above, the Notice provides information regarding the conversion of a general-purpose health FSA to an HSA-compatible health FSA to permit individuals with a health FSA carryover to qualify to make contributions to an HSA.
Extended Grace Period Relief
The CAA allows employers to extend the grace period to apply unused amounts remaining in a health FSA or DCAP for plan years ending in 2020 or 2021, to 12 months after the end of that plan year.
The Notice clarifies that an employer may choose to adopt:
Like the carryover relief, the extended grace period relief is available to cafeteria plans that currently have a grace period or provide for a carryover, as well as plans that do not have a grace period or provide for a carryover—despite the general rule that an FSA can adopt either a grace period or provide for a carryover amount but cannot have both (which otherwise continues in effect).
Impact on Eligibility to Contribute to an HSA
According to the Notice, an individual is not eligible to make HSA contributions if the individual participates in a general-purpose health FSA, including during any extended grace period in which the participant can incur claims. However, the Notice provides information regarding the conversion of a general-purpose health FSA to an HSA-compatible health FSA. Employers also are permitted to amend their plans to allow employees, on an employee-by-employee basis, to opt out of any extended grace period in plan years ending in 2021 and 2022, to preserve their HSA eligibility.
Post-termination Health FSA Reimbursements
The CAA provides that a health FSA may allow employees who cease participation during calendar year 2020 or 2021 to continue to receive reimbursements from unused amounts through the end of that plan year (including any grace period, extended or not). Employers are permitted to limit the unused amounts in the health FSA to the amount of contributions the employee had made from the beginning of the plan year in which participation ceased, up to the date of cessation.
This option is available for an employee who ceases to be a participant as a result of:
Interaction of Carryover and Extended Grace Period Relief
Amounts carried over or available during an extended grace period will not be taken into account for purposes of:
Carryovers & Grace Periods for Plan Years Ending in 2022
The otherwise applicable rules regarding carryovers and grace periods will apply for plan years ending in or after 2022, as illustrated in the table below.
|Plans with a grace period for plan years ending in 2022||The grace period would allow a participant to use all unused amounts remaining at the end of the plan year ending in 2022 for expenses incurred during the first 2 ½ months of the plan year ending in 2023.|
|Plans providing for a carry over for plan years ending in 2022||The carryover would allow the participant to use up to $550 (or, if greater, 20% of the indexed FSA contribution limit) of unused amounts remaining at the end of the 2022 plan year for expenses incurred during any month of the plan year ending in 2023. In accordance with otherwise applicable rules, for plan years ending in or after 2022, the carryover is available only for a health FSA and is not available for a DCAP.|
The CAA provides that cafeteria plans may permit employees to make prospective mid-year election changes for health FSAs and DCAPs for plan years ending in 2021, even if they have not experienced a change in status. Specifically, employers may allow employees to prospectively revoke an election, make one or more elections, or increase or decrease an existing election for plan years ending in 2021 regarding a health FSA or DCAP.
The Notice illustrates the discretion employers have in implementing this election relief. Specifically, employers are permitted to:
The Notice clarifies that prospective election changes may include an initial election to enroll in a health FSA or DCAP for the year (e.g., to gain use of the carryover or extended grace period relief), if the employee initially declined to enroll in the health FSA or DCAP for the year.
Although election changes may only be applied prospectively, employers may allow employees to use funds contributed to a health FSA or DCAP following a revised election to reimburse expenses incurred at any time during the first plan year that begins on or after Jan. 1, 2021, through the end of the 2021 plan year.This relief extends to expenses incurred by employees who were not enrolled in the health FSA or DCAP on Jan. 1, 2021.
Note: This relief does not allow unused amounts to be paid to an employee in cash or paid to an employee in the form of any taxable or nontaxable benefit without regard to whether the employee incurs medical or dependent care expenses during the period of coverage.
Prospectively Revoking Elections
If a health FSA or DCAP election is revoked, the treatment of amounts previously contributed is subject to the terms of the plan, which must apply uniformly to all participants. The plan may provide that amounts contributed before the revocation:
In addition, employers can allow employees to elect to revoke elections under a health FSA or DCAP as of a future specified date.
Impact on Eligibility to Contribute to an HSA
If the plan provides that election revocation terminates participation in the health FSA, and that no subsequent reimbursements will be available (regardless of when the expense is incurred), following the revocation, the health FSA will no longer be treated as health coverage that disqualifies an otherwise eligible individual from contributing to an HSA. In this case, an otherwise eligible individual may begin contributing to an HSA as soon as the termination of participation is effective.
Similarly, if the health FSA reimburses only expenses incurred before the revocation date, following the revocation, the health FSA will not be treated as health coverage that disqualifies an otherwise eligible individual from contributing to an HSA for the months after the revocation date.
Special Age Limit Relief for DCAPs
The CAA includes a special carry forward rule for dependent care FSAs where the dependent aged out during the pandemic. Specifically, for purposes of determining dependent care assistance that may be paid or reimbursed, the maximum age is increased from 13 to 14 years of age. Only certain employees are eligible for this relief.
The Notice makes clear that this special age limit relief does not permit an employer to reimburse expenses for a child who is 14 years or older. If an employer adopts this relief, then all amounts from the most recent plan year with regard to which the regular enrollment period ended on or before Jan. 31, 2020, may be applied to dependent care expenses for a dependent who attained age 13 during that plan year. In this case, employers may allow employees to carry over all unused amounts from that first plan year to reimburse dependent care expenses during the subsequent plan year (until that dependent attains age 14).
Lastly, the Notice clarifies that this special age limit relief is separate from the general carryover and extended grace period relief. Thus, employers are not required to adopt the carryover or extended grace period relief in order to adopt the special age limit relief.
Employers deciding to implement the CAA and the Notice relief for one or more of its cafeteria plans (including plans that do not currently have a grace period or permit a carryover) must adopt a plan amendment to do so. Such an amendment may be effective retroactively to the beginning of the applicable plan year, so long as:
Amendments Incorporating Carryover and Extended Grace Period Relief
An employer may not amend its plan to adopt both the carryover and the extended grace period for a particular plan year for a particular health FSA or DCAP, and an amendment must specify which option is adopted for the applicable plan years. An employer can adopt this relief for some, but not all, health FSA or DCAP participants (subject to applicable nondiscrimination rules under Internal Revenue Code Sections 125 and 129). An employer may also choose to adopt one type of relief, or no relief, for a health FSA and a different type of relief, or no relief, for a DCAP. An employer that offers multiple health FSAs or DCAPs may also adopt differing relief for each particular health FSA or DCAP.
Impact on COBRA
Adopting Carryover or Extended Grace Period Relief
If an employer adopts a carryover or extended grace period under the CAA, the maximum amount that the health FSA may require to be paid as the applicable COBRA premium does not include unused amounts carried over or available during the extended grace period. Thus, if a qualified beneficiary is allowed a carryover to a later plan year or an extended grace period, the applicable COBRA premium payable to provide access to the carryover amounts or the amounts attributable to the extended grace period for that later year or for the extended grace period is zero.
In addition, amounts carried over or available during the extended grace period are included in the amount of the benefit that a qualified beneficiary is entitled to receive during the remainder of a plan year in which a qualifying event occurs.
Adopting Post-termination Health FSA Reimbursement Relief
If an individual is otherwise a qualified beneficiary with respect to coverage by a health FSA, the limited post-termination health FSA reimbursement period will not prevent the individual from having a loss of coverage resulting in a qualifying event (for example, by termination of employment or reduction in hours of a covered employee), and the relevant employer will be subject to COBRA’s notice requirements.
Source – Zywave, Inc.