IRS Allows Unprecedented Mid-Year Election Changes under Section 125 Cafeteria Plans
Under new guidance released by the IRS (IRS Notice 2020-29), employers may allow employees to make mid-year pre-tax election changes under a Section 125 Cafeteria Plan (“Cafeteria Plan”) for any reason during the 2020 calendar year. This increased flexibility to make mid-year election changes applies to employer-sponsored health coverage, and Health and Dependent Care Flexible Spending Accounts (“FSAs”). The IRS also extended the time period in which eligible expenses may be incurred under FSAs with plan years and grace periods that end during the 2020 calendar year.
This IRS guidance also provided additional clarification on coverage of COVID-19 testing and treatment, and telehealth services (or medical services provided in other remote care settings) by high deductible health plans (“HDHPs”). The IRS clarified that coverage of these services by HDHPs on or after January 1, 2020 will not cause the HDHP to lose its status as an HDHP and, as a result, will not jeopardize the HSA eligibility of a participant in the HDHP.
In separate IRS guidance issued on the same day (IRS Notice 2020-33), the IRS increased the allowable carryover for Health FSAs to $550 (from $500) for carryovers from a Cafeteria Plan’s 2020 plan year to its 2021 plan year. This carryover amount will be further indexed for inflation in the future (in connection with annual adjustments to the cap on an employee’s salary reduction contributions to a Health FSA).
Cafeteria Plan Elections
If an employer offers an employee a choice between taxable compensation and a non-taxable benefit, the employee is generally subject to tax on the compensation, even if the employee elects the non-taxable benefit. Cafeteria Plans generally allow eligible employees to avoid these adverse tax consequences by permitting eligible employees to select taxable compensation or having their compensation reduced on a pre-tax basis to pay for the employee’s portion of a non-taxable benefit. A fundamental rule of Cafeteria Plans is that employees must make elections under a Cafeteria Plan before the beginning of the Cafeteria Plan’s plan year and those elections may only be changed mid-plan year if employee incurs a permissible mid-year change event.
Relief in Notice 2020-29
In IRS Notice 2020-29, the IRS permits employers to allow employees to make mid-year election changes during the 2020 calendar year, regardless of whether the employee incurs a permissible mid-year change event. Specifically, the following mid-year election changes are allowed during the 2020 calendar year, but only on a prospective basis:
- With respect to employer-sponsored health coverage:
- An eligible employee may elect to enroll in employer-sponsored coverage mid-year if the employee initially declined to enroll in that coverage.
- An employee may elect to revoke an existing election and make a new election to enroll in different health coverage sponsored by the same employer (e.g., revoke an election under the employer’s HDHP and, instead, enroll in the employer’s traditional group health plan). This includes the right to select a different coverage tier (e.g., moving from single-only to family coverage).
- An employee may elect to revoke an existing election to enroll in health coverage sponsored by the employer and enroll in other comprehensive health coverage, generally provided that the employee attests in writing that the employee is enrolled, or will immediately enroll, in other comprehensive health coverage (e.g., dropping health coverage sponsored by an employee’s own employer to enroll in health coverage sponsored by the employer of the employee’s spouse or parent). Notice 2020-29 provides sample language that can be used for an employee to make this written attestation.
- With respect to Health and Dependent Care FSAs, an employee may: (1) revoke an election to participate in a Health or Dependent Care FSA; (2) make a new election to participate in a Health or Dependent Care FSA; (3) decrease pre-tax salary reductions to a Health or Dependent Care FSA; or (4) increase pre-tax salary reductions to a Health or Dependent Care FSA.
Miller Johnson’s Comments
- A group health plan—whether fully insured or self-funded—is not legally required to allow mid-year enrollments unless the individual requesting mid-year enrollment has incurred a HIPAA special enrollment event. If an employer is interested in voluntarily expanding the mid-year election opportunities for 2020, before proceeding, the employer should confirm with its carrier (for fully insured plans) or stop-loss carrier (for self-funded plans) that the carrier will honor these mid-year changes. Fortunately, carriers have been more flexible with respect to mid-year enrollments during the COVID-19 pandemic.
- Employers that want to allow these optional mid-year changes for 2020 may set limitations on what changes will be allowable (e.g., to reduce adverse selection or administrative burdens).
- Notice 2020-29 provides the following examples of these limitations: (1) only allowing mid-year changes that result in increased or improved coverage; (2) only allowing an employee to enroll the employee’s eligible dependents (i.e., switching from single-only to family coverage); and (3) only allowing an employee to move from a low option plan that only covers in-network expenses to a high option plan that covers both in- and out-of-network expenses.
- An employer that offers a traditional plan and HDHP may consider only allowing employees to change from the HDHP to the traditional plan—but not the other way around—to reduce burdens with respect to tracking deductibles for purposes of HSA eligibility.
- Employers should be aware that employees who request to drop employer-sponsored coverage mid-year may not be eligible to enroll in other coverage mid-year absent a HIPAA special enrollment event.
- With respect to Health FSAs, an employer that permits employees to decrease the amount of the employee’s salary reduction contributions mid-year should not allow a decrease below the amount for which the employee has already been reimbursed. (Since Dependent Care FSAs are not subject to the “uniform coverage” rule, this should not be an issue for Dependent Care FSAs.)
Health and Dependent Care FSA Grace Periods
Many Cafeteria Plans contain Health and/or Dependent Care FSAs. Generally, in order for an eligible medical expense or dependent care expense to be reimbursed by a Health FSA or Dependent Care FSA, a participant in the Health or Dependent Care FSA must incur the eligible expense during the Cafeteria Plan’s plan year. If a participant has an FSA account balance as of the end of the plan year, that account balance is forfeited.
There are two exceptions to this forfeiture rule. Health and Dependent Care FSAs may offer a “grace period”—which is a period of not more than 2.5 months following the end of the Cafeteria Plan’s plan year—in which a participant may incur an eligible expense and be reimbursed by the Health or Dependent Care FSA from the FSA account balance for the previous plan year.
The other exception only applies to Health FSAs—but not Dependent Care FSAs—and allows participants to carry over up to $500 of the participant’s Health FSA account balance to the next plan year (this rule is frequently referred to as the “carryover” rule). Cafeteria Plans may impose certain restrictions on Health FSA carryovers. A Health FSA may offer a grace period or a carryover, but not both.
Relief in Notice 2020-29
For any plan year or grace period that ends during the 2020 calendar year, a Cafeteria Plan may allow eligible expenses to be incurred until December 31, 2020 and be reimbursed from a participant’s remaining account balance for the previous plan year (if any).
Example. Assume that a Cafeteria Plan’s plan year was July 1 to June 30. The Cafeteria Plan provided for the 2.5 month grace period for the Cafeteria Plan’s Health and Dependent Care FSAs. For the 2019-2020 plan year, participants would normally need to incur eligible expenses by September 15, 2020 to be reimbursed from the account balance under the participant’s Health FSA or Dependent Care FSA for the Cafeteria Plan’s 2019-2020 plan year. Under the relief provided by Notice 2020-29, the Cafeteria Plan may allow participants to submit reimbursement claims from the participant’s Health and Dependent Care FSA account balances for the 2019-2020 plan year for eligible expenses incurred on or before December 31, 2020.
The guidance also indicates that a Health FSA that provides the carryover option (instead of the grace period) can offer this extension of time for eligible Health FSA claims to be incurred, as long as the plan year ends during the 2020 calendar year.
Example. Assume that a Cafeteria Plan’s plan year was July 1 to June 30. The Cafeteria Plan provided for a carryover of up to $500 of a participant’s unused Health FSA account balance at the end of each plan year. In this situation, the Health FSA can allow a participant to submit claims for reimbursement from the participant’s Health FSA account balance for the 2019-2020 plan year for eligible medical expenses that were incurred on or before December 31, 2020. If any of the participant’s Health FSA account balance remains after December 31, 2020, that amount—up to $550—to be carried over to the 2020-2021 plan year (see below regarding the increase in the carryover from $500 to $550).
Miller Johnson’s Comments
- The extension of deadlines to incur eligible expenses that are reimbursable from a Health or Dependent Care FSA only applies to Cafeteria Plan’s that: (1) have non-calendar year plan years; or (2) have calendar year plan years and offer a grace period (vs. carryover). If a Cafeteria Plan with a calendar year plan year offers a carryover, there is no plan year or grace period that ends in 2020 that can be extended until December 31, 2020.
- Employers that want to offer these extensions should discuss this with the TPA for its Health and Dependent Care FSAs as soon as possible. We understand that many TPAs’ Health and Dependent Care FSA administration systems are highly automated. So offering these extensions may require significant reprogramming of their automated systems. (Especially for Cafeteria Plans with non-calendar year plan years that currently offer a carryover as the carryover calculation will need to be coordinated with these extended deadlines.)
- Grace periods should not be confused with “run-out” periods. A grace period provides a participant in a Health or Dependent Care FSA with additional time to incur claims that may be reimbursed by the Health or Dependent Care FSA. A run-out period provides a participant with additional time to submit claims for reimbursement under a Health or Dependent Care FSA, as long as the claim was incurred within the Cafeteria Plan’s plan year or grace period. For employers that want to offer these extended deadlines to incur claims, they should consider how this will coordinate with the extension of run-out periods during the “outbreak period” under recently issued DOL/IRS regulations (see our previous client alert here).
Increase in Health FSA Carryover
As explained above, Health FSAs may offer a carryover option as an exception to the rule that unused amounts under a participant’s Health FSA must be forfeited at the end of the Cafeteria Plan’s plan year. If a Health FSA offers the carryover, it cannot also offer a grace period. The amount that a participant may carryover is currently limited to $500 (however, this limit can be reduced at the option of the Cafeteria Plan’s sponsor). This $500 limit has not changed since carryovers were first allowed in 2013.
Relief in Notice 2020-33
IRS Notice 2020-33 allows the sponsor of a Cafeteria Plan to increase the amount of the Health FSA carryover to $550 (from the $500 limit) for carryovers beginning with the Cafeteria Plan’s 2020 plan year to the 2021 plan year. Further, this carryover limit may be annually adjusted by the IRS for inflation (similar to the cap on a participant’s salary reduction contributions to a health FSA).
- All of the changes explained above are optional to sponsors of Cafeteria Plans. That means that employer-sponsors could incorporate into their Cafeteria Plans all, some, or none of the changes above.
- Other than the change with respect to the increased Health FSA carryover, all of the changes above are temporary. Regardless of a Cafeteria Plan’s plan year, these changes only apply during the 2020 calendar year.
- For Cafeteria Plan sponsors that want to incorporate these changes, the Cafeteria Plan will need to be amended. The IRS provides time to adopt formal written amendments to Cafeteria Plans and—in the meantime—allow the Cafeteria Plan to be operated as if it were amended. Specially, Cafeteria Plans must be formally amended by December 31, 2021 to include any of the changes other than the change to increase the Health FSA carryover. A Cafeteria Plan must be amended by the last day of the first plan year beginning in 2021 to include the increased carryover of $550 for Health FSAs for 2020.
- Participants are required to be notified of the changes to Cafeteria Plans. As explained in our previous client alert (available here), these notices may generally be provided electronically during the COVID-19 “outbreak period” as long as the employer acts in “good faith” and “reasonably believes” that the recipient has “effective access” to the electronic notification.
- While employers should work with their legal counsel to prepare formal plan amendments, we recommend that employers also communicate with their TPAs for their Health and Dependent Care FSAs. Just because all of these changes are allowed by the IRS, a TPA may have administrative burdens with their implementation.
Notice 2020-29 also provides the following clarification regarding coverage of COVID-19 testing and treatment, and telehealth (or medical services provided in other remote care settings) provided by HDHPs:
- In IRS Notice 2020-15, the IRS clarified that a HDHP “will not fail to be an HDHP merely because the [HDHP] provides medical care services and items purchased related to testing for and treatment of COVID-19 prior to the satisfaction of the applicable minimum [HDHP] deductibles” (see our previous client alert here). Notice 2020-33 extends this relief to include diagnostic testing for influenza A and B, norovirus and other coronaviruses, and respiratory syncytial virus (“RSV”). Notice 2020-33 also clarifies that the relief in Notices 2020-15 and 2020-33 applies retroactive to January 1, 2020.
- Under the FFCRA and the CARES Act, all health plans—including HDHPs—are required to provide coverage of COVID-19 testing and treatment in all settings including through telehealth services and other remote care settings (see our previous client alerts here and here). This requirement was effective on March 18, 2020, which was the date the FFCRA was enacted. The CARES Act clarified that coverage of all telehealth services (and other remote care settings) without the application of the minimum HDHP deductibles would not jeopardize a HDHP’s status as an HDHP (or the HSA eligibility of the participants in the HDHP). Notice 2020-33 clarified that this relief applies retroactively to all telehealth services and other remote care setting services provided by an HDHP on or after January 1, 2020. (Generally, these services can only be provided by an HDHP without the application of the minimum HDHP deductibles through the HDHP’s first plan year beginning on or after January 1, 2022.)
This additional relief will likely be welcomed by employers and participants in Section 125 plans and HDHPs. However, similar to the extensions of various deadlines during the “outbreak period,” it is likely to cause administrative burdens to employers and their TPAs. We recommend that employers and their TPAs begin discussing these issues with legal counsel and other interested parties (e.g., software providers) as soon as possible.
For more information or if you have any questions, please contact one of the Miller Johnson employee benefits attorneys listed to the left.