Your Patience Paid Off: IRS Releases Guidance on FSA Flexibility under the CAA
We anticipated that the IRS would issue additional guidance on the temporary FSA changes permitted by the Consolidated Appropriations Act, 2021 (“CAA”). On February 18, 2021, it did. This client alert summarizes this IRS guidance, which was released in Notice 2021-15. (For a summary of the changes allowed by the CAA, see our client alert here.)
- Retroactively Amending Plans for OTC Drugs and Menstrual Care Products. Notice 2021-15 provides relief with respect to the deadline to amend health FSAs and HRAs to reimburse over-the-counter (“OTC”) medicines and drugs without a prescription, and menstrual care products. In our previous client alert and webinar, we explained problems under current rules with respect to retroactive amendments. Notice 2021-15 allows retroactive amendments to health FSAs and HRAs to cover OTC medicines and drugs, and menstrual care products as of January 1, 2020.
- Mid-Year Election Changes to Employer-Sponsored Health Coverage. Notice 2021-15 extends to calendar year 2021 the flexibility for employers to allow various mid-year election changes under a Section 125 Cafeteria plan with respect to employer-sponsored health coverage, which was originally permitted for calendar year 2020 under Notice 2020-29 (see our previous client alert here). Notice 2021-15 clarifies that employer-sponsored health coverage includes health, dental, and vision coverages.
- Mid-Year Changes Between General and Limited-Purpose Health FSAs. During 2021, a Section 125 plan may be amended to allow employees to make mid-year election changes to move from a general purpose to limited-purpose health FSA (or vice versa). Employers that have added a HDHP option during the middle of a health FSA plan year know the frustrations associated with this. If you are contemplating the addition of a HDHP, 2021 may be the year to do it.
- Mid-Year Election Changes to Health FSAs and Dependent Care FSAs. The CAA’s flexibility to make various mid-year election changes under a health FSA or dependent care FSA includes:
- The ability to make an election to enroll in a health FSA or dependent care FSA to gain access to the increased carryover or extended grace period if the employee initially declined to enroll for the plan year (assuming the employer conditions access to these features to only participants in the health FSA or dependent care FSA in the next plan year, which Notice 2021-15 also clarifies is permissible).
- For employees who enroll in a health FSA or dependent care FSA mid-year, the employer may allow amounts contributed after the election change to be used for eligible expenses incurred at any point during the plan year, even those incurred before the date of the election change.
- With respect to elections to terminate participation in a health FSA or dependent care FSA, a Section 125 plan may allow amounts contributed before the effective date of the termination to reimburse eligible expenses incurred after the termination date through the end of the plan year. Alternatively, the plan may limit reimbursement to only eligible expenses incurred before the termination date (which may be helpful if a participant terminates participation in a health FSA in order to become HSA eligible). In addition, elections to terminate participation may be made as of a future specified date.
- An employer is permitted to limit mid-year election changes to certain types, such as only to decrease the amount of the participant’s contributions.
- 2020 and 2021 Plan Year Carryovers. The CAA permits the carryover of a participant’s entire unused balance in a health FSA or dependent care FSA for plan years ending in 2020 and 2021. Notice 2021-15 clarifies:
- The carryover may be added regardless of whether the plan previously offered a carryover. For example, if a plan didn’t offer a carryover under a health FSA for the 2020 plan year, the guidance allows the plan to be amended to add a carryover under the CAA in 2020, even though the plan year is over.
- A carryover is not permitted if the health FSA or dependent care FSA offers a grace period. However, a plan may temporarily “suspend” the grace period in order to allow an unlimited carryover permitted by the CAA.
- Participants may opt out of the carryover on a participant-by-participant basis (e.g., to preserve HSA eligibility.)
- Extended Grace Periods. The CAA permits health and dependent care FSA grace periods ending in 2020 and 2021 to be extended for up to 12 months after the end of the plan year for which the grace period applies. Similar to carryovers for the 2020 and 2021 plan years, Notice 2021-15 clarifies:
- The ability to extend grace periods ending in 2020 or 2021 is allowed regardless of whether the plan previously offered a grace period. For example, if a plan did not offer a grace period under a dependent care FSA in the 2020 plan year, the guidance allows the plan to be amended to add an extended grace period under the CAA in 2020, even though the plan year is over.
- An extended grace period is not permitted if the health FSA or dependent care FSA offers a carryover. For a health FSA that previously offered a carryover, the plan may temporarily “suspend” the carryover to allow for an extended grace period.
- Participants may opt out of the extended grace period on a participant-by-participant basis (e.g., to preserve HSA eligibility.)
- Interaction of Carryovers and Extended Grace Periods. In general, the flexibility offered by increased carryovers and extended grace periods under the CAA provides similar relief. Both provisions allow all unused benefits remaining for plan years ending in 2020 and 2021 to be made available for eligible expenses incurred in the immediately following plan year.
A notable difference, however, is if an employee terminates participation before the end of the plan year. If a health FSA or dependent care FSA offers a carryover, an employee who terminates participation during the plan year is not eligible to be reimbursed for expenses incurred in the next plan year, even if the participant had a balance in the FSA as of the date of termination. On the other hand, if the FSA offers an extended grace period and the spend down feature, the FSA may allow the reimbursement of the employee’s eligible expenses incurred during the next plan year to the extent of the employee’s balance as of the date of termination. This may be one reason to “suspend” the carryover and allow the extended grace period.
- Health FSA Spend Downs. If employers allow a health FSA spend down after the termination of participation (as temporarily permitted by the CAA), the time period to spend down the health FSA may be limited. In other words, employers are not required to allow the spend down of a health FSA through the end of the plan year in which the termination of participation occurs. Notice 2021-15 also clarifies that the spend down feature under a health FSA does not relieve the employer of its requirement to offer COBRA continuation coverage under the health FSA.
- Reporting Requirements for Dependent Care FSAs. Amounts contributed to a dependent care FSA are required to be reported in Box 10 of Form W-2. Notice 2021-15 clarifies that employers are not required to adjust the amount reported in Box 10 to take into account amounts that remain available in a grace period (including amounts available due to an extended grace period or increased carryover).
Employers that wish to implement any of the changes permitted by the CAA or Notice 2021-15 should consult with their third party administrators as soon as possible to confirm their ability to implement the changes. In addition, employers should notify participants of any changes as soon as possible to allow the participants an opportunity to take advantage of the changes.
We are happy to assist you with any necessary amendments or participant communications, and to answer any questions about this client alert, the CAA or Notice 2021-15. Please contact the authors or one of the Miller Johnson employee benefits attorneys.