IRS Provides New Flexibility for Cafeteria Plans, Flexible Spending AccountsMay 13, 2020 – Alerts
Continuing its approach toward relaxing employee benefit rules and providing flexibility to employees in addressing the many challenges caused by the COVID-19 pandemic, the IRS issued two additional notices on May 12, 2020, focusing on health and welfare benefits.
Notice 2020-29 and Notice 2020-33 extend both temporary relief during the 2020 calendar year, and permanent relief, in the form of:
- Liberalized mid-year changes to elections under Section 125 cafeteria plans;
- Increased carryover of unused amounts in health flexible spending accounts (FSAs); and
- Health expense reimbursement.
Relaxed Cafeteria Plan Rules
A Section 125 cafeteria plan enables participating employees to pay for health insurance premiums, health care expenses not covered by insurance, dependent care and other employee benefits on a pre-tax basis through salary reduction. The election of benefits (in lieu of cash compensation) must be made prior to the beginning of the plan year and, generally, is irrevocable. Midyear changes to elections normally are restricted to those related to change of status events (marriage, divorce, birth or adoption of a child, etc.) or significant change in benefit cost.
Notice 2020-29 relaxes those restrictions during calendar year 2020, permitting employees to:
- Make a new election of coverage under the employer-sponsored health plan, if the employee initially declined the coverage;
- Revoke an existing election so as to enroll in different group health coverage maintained by the employer or to extend coverage to family members;
- Revoke an existing election so as to enroll in other health coverage not sponsored by the employer (such as coverage offered by a spouse’s employer);
- Revoke an existing election, make a new election or adjust the amount of an existing election with respect to a health FSA; and
- Revoke an existing election, make a new election or adjust the amount of an existing election with respect to a dependent care assistance program.
These changes may be made on a prospective basis only. In addition, in order to revoke an election so as to drop coverage in the employer-sponsored health plan, the employee must provide written attestation that he is enrolled, or immediately will enroll, in other comprehensive health coverage not sponsored by the employer. (The notice includes a sample of an acceptable written attestation.) The employer is entitled to rely on the accuracy of the employee’s statement in the absence of actual knowledge to the contrary.
Adoption or Extension of Grace Periods
Health FSAs and dependent care assistance programs may extend grace periods (which otherwise would have ended earlier in 2020) so that unused amounts may be used to pay or reimburse expenses incurred through December 31, 2020. Health FSAs which allow for carryover of unused amounts (and normally would not be permitted to offer grace periods) may adopt a grace period for 2020 only.
Increased Health FSA Carryover Amount
In 2013, the IRS modified its long-standing “use-or-lose” rule to permit a Section 125 cafeteria plan to allow participants to carry over up to $500 in unused health FSA amounts for use in reimbursing permissible medical care expenses incurred in the following plan year. In Notice 2020-33 the IRS increases the maximum amount that may be carried over in an FSA from one plan year to the next from $500 to $550. In future years, this amount is to be indexed, based on 20% of the maximum salary reduction contribution permitted for health FSAs.
Relatedly, Notice 2020-29 allows individuals to make a mid-year election change if, in response to the increased carryover amount, they wish either to begin making FSA contributions or to increase their existing amounts.
Changes Are Optional
These changes, however, are completely optional on the part of employers. Each employer/plan sponsor may determine the extent to which it will permit election changes. The IRS recognizes that employers may wish to limit elections to those which will increase or improve an employee’s coverage so as to prevent adverse selection.
Required Plan Amendment and Notice to Employees
To the extent an employer chooses to permit these mid-year election changes and/or provide an expanded grace period, the Section 125 cafeteria plan must be amended. The plan amendment must be adopted by December 31, 2021, but may be made effective retroactively to January 1, 2020, provided that the plan is operated in accordance with the notice in the interim, and provided that the employer informs all eligible employees of the changes.
Individual Coverage HRAs
Notice 2020-33 also provides flexibility and clarity on the timing of premium payments by individual coverage health reimbursement arrangements (ICHRAs). According to the notice, a plan is permitted to treat a premium expense as incurred on
- The first day of each month of coverage on a pro rata basis;
- The first day of the period of coverage; or
- The date the premium is paid.
This is in line with 2017 guidance relating to qualified small employer HRAs.
ICHRAs are considered employer-sponsored health plans, and reimbursements for premiums from the plans are eligible for exclusion from employees’ gross income under Code §§ 105 and 106. Notice 2020-33 clarifies the timing issue when a payment is made in one calendar year for coverage in the next (as, for example, in the case of a calendar year ICHRA, a premium is paid in December for coverage during the following January.)