New Law Provides Temporary Special Relief for Flexible Spending Arrangements
1.19.21 | Client alert
The Consolidated Appropriations Act, 20211 (the “Act”), which was signed into law at the end of 2020, is one of several COVID-19 stimulus packages intended to provide much needed economic relief during a public health emergency. To address unanticipated changes in health and childcare expenses resulting from the COVID-19 pandemic, the Act includes several temporary special rules designed to relax existing rules applicable to health and dependent care flexible spending arrangements (“FSAs”).
An FSA is a benefit program provided by an employer that allows an employee (a “participant”) to be reimbursed for specified expenses (e.g., medical or dependent care expenses) from an account funded with the participant’s pre-tax earnings (so that these amounts are excluded from the participant’s gross income). To qualify for this favorable tax treatment, FSAs must incorporate certain requirements. One such requirement, intended to prevent deferred compensation, is the “use it or lose it” rule which provides that any unused funds in the FSA at the end of the year are generally forfeited.
As a result of the pandemic, many health care providers limited routine visits and cancelled elective treatments during 2020. In addition, childcare services were suspended for much of the year as a result of quarantine, lock-down and shelter-in-place restrictions. This left many participants with unused funds in FSAs that were funded with the expectation that such treatments and childcare would be available.
Under permanent rules, employers have limited ability to alleviate forfeiture by allowing a small carryover of unused funds to the next plan year (capped at $550 for 2020 carryovers)2 or permitting a short grace period following the end of the plan year (up to 2 months and 15 days) during which claims could be incurred and applied to the prior year’s FSA amounts. Prior COVID-19 relief expanded an employer’s ability in this regard by permitting them to amend their plans to allow participants to apply unused amounts remaining in the FSA at the end of a plan year ending in 2020 or a grace period ending in 2020 to reimburse qualified expenses incurred through December 31, 2020.3
The Act gives employers additional flexibility to minimize forfeiture of FSA funds and maximize their use by relaxing and expanding FSA requirements. It does this in several ways:
Relief from the “Use it or Lose it” Rule
For FSAs where employers allow carryover of unused benefits, employers may now amend both health and dependent care FSAs to permit all unused funds from plan years ending in 2020 and 2021 to be carried over into the next plan year. Carryovers were previously permitted only for health FSAs (and as noted above, were not unlimited).
For FSAs that provide a grace period, employers may now amend their health and dependent care FSAs to extend the grace period for plan years ending in 2020 and 2021 up to a full 12 months after the end of the plan year.
FSA Election Period Relief
In general, elections regarding FSAs must be irrevocable and must be made prior to the start of the plan year. An employer, however, could permit mid-year election changes upon the occurrence of certain events (such as a change in the participant’s status or significant changes in the cost of coverage). Because the effects of the pandemic were not known when elections had to be made for a 2020 plan year, many participants overfunded their FSAs, while others (who incurred significant medical expenses or increased dependent care expenses due to the virus) underfunded their FSAs.
Earlier pandemic relief gave employers flexibility to amend their FSAs to permit mid-year election changes for plan years ending in 2020, without regard to a permissible change event.4 The Act extends this flexibility by permitting employers to amend their heath FSAs and dependent care FSAs to allow participants to prospectively change their elections during plan years ending in 2021.
Relief for Former Employees
Employers may now amend their health FSAs to allow a participant who’s employment terminated during a 2020 or 2021 plan year to spend down any unused funds by continuing to incur reimbursable expenses through the end of the plan year in which the termination occurred (plus any grace period, including the expanded grace period described above). Under prior rules, employers already had the option to include a spend down provision in dependent care FSAs.
Relief for Aged-Out Dependents
Generally, childcare expenses qualify for FSA reimbursement only until the child attains age 13. The Act permits employers to amend their dependent care FSAs to extend the disqualifying age to 14 for plan years whose open enrollment period ended on or before January 31, 2020 (in effect, a 2020 plan year). This would allow a participant to be reimbursed for childcare expenses through the end of the plan year in which the child turns 13, and if there are unused funds in the FSA at the end of the plan year, to be reimbursed from such funds for childcare expenses incurred during the following plan year, but only until the child attains age 14.
While the goal of the Act is to provide FSA participants greater flexibility to manage their health and childcare benefits during uncertain times, the above amendments are all voluntary. Employers are not required to adopt any of the new temporary rules. Should an employer wish to do so, the employer must amend its FSA plan documents to incorporate the temporary rules. The amendment must be adopted no later than the last day of the first calendar year beginning after the end of the plan year in which the amendment is to be effective. For example, an amendment that is to be effective as of January 1, 2020 (i.e., a 2020 plan year) must be adopted prior to December 31, 2021. If an amendment is adopted retroactively, the plan must be administered consistent with such amendment during the retroactive period.
For more information on this topic or any other matter related to the COVID-19 pandemic, please contact your Berdon advisor.
This alert is for general information purposes only and is not intended, and should not be construed, as legal or tax advice.
1 CAA, 2021, PL 116-260.
2 See Internal Revenue Service (“IRS”) Notice 2020-33.
3 See IRS Notice 2020-29. The Notice makes the extended grace period available for FSAs that provide a carryover feature, notwithstanding the normal rule that prohibits an FSA from having both a grace period and a carryover feature. See IRS Notice 2013-71.
4 IRS Notice 2020-29.