IRS Clarifies Temporary FSA Rules | M3 Insurance

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IRS Clarifies Temporary FSA Rules

Employee Benefits

On February 18, 2021, the IRS issued IRS Notice 2021-15 to provide further clarification on previously issued temporary special rules related to health Flexible Spending Arrangements (FSAs) and dependent care assistance plans (DCAPs). In addition, the Notice provides election change relief for employer sponsored health coverage and mid-year changes between health FSAs and Health Savings Account (HSA)-compatible health FSAs (limited purpose FSAs).

Carryover Balances

Previous Guidance (Section 214 guidance)

Allows Section 125 plan sponsors to provide a carry-over of unused amounts remaining in a health FSA or DCAP to pay or reimburse medical care and dependent care expenses in a subsequent plan year.

  • Plan sponsors may permit participant to carry over unused benefits or contributions from plan years ending in 2020 to plan years ending in 2021.
  • Plan sponsors may permit participants to carry over unused benefits or contributions from plan years ending in 2021 to plan years ending in 2022.

Clarifications

  • The Section 214 carryover 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 carryover.
  • Employers may limit the carryover to an amount less than all unused amounts and may limit the carryover to apply only up to a specified date during the plan year.
  • Amounts carried over are not taken into account for the maximum benefit limit for that year.
  • Individuals are NOT eligible to make contributions to an HSA during any month in which the individual participates in a general purpose health FSA to which unused amounts are carried over.
  • Plan sponsors may amend their plans to allow employees, on an employee by employee basis, to opt out of the carryover to preserve HSA eligibility.
  • Previous applicable rules regarding carryovers will apply for plan years ending on or after Plan Year 2022.
  • Relief may be adopted for some but not all FSA and DCAP participants, subject to Section 125 non-discrimination rules.
  • Amounts available as a result of a carryover will not be taken into account for the purpose of non-discrimination rules.

Grace Periods

Previous Guidance (Section 214 guidance)

Allows Section 125 plan sponsors to provide an extended period (grace period) to apply unused amounts remaining in health FSA or DCAP to pay or reimburse medical and dependent care expenses.

  • The extended grace period can be up to twelve (12) months.
  • Unused amounts remaining in a health FSA or DCAP as of 12/31/2020 could be used to reimburse medical or dependent care expenses incurred through 12/31/2021.
  • Unused amounts remaining in a health FSA or DCAP as of 12/31/2021 could be used to reimburse medical or dependent care expenses incurred through 12/31/2022.

Clarifications

  • Plan sponsors may adopt an extended period for incurring claims that is less than twelve (12) months and a plan sponsor may choose to adopt a period that ends before the end of the plan year during which participants who have ceased participation in a plan may continue to receive reimbursements.
  • Plans may not have both carryover and grace period provisions.
  • Individuals are not eligible to make contributions to an HSA if the individual participates in a general purpose health FSA, including during any extended period in which the participant can incur claims.
  • Plan sponsors may amend their plans to allow employees, on an employee by employee basis, to opt out of any extended period for incurring claims in plan years ending in 2021 and 2022 to preserve HSA eligibility.
  • Previous applicable rules regarding grace periods will apply for plan years ending on or after Plan Year 2022.
  • Relief may be adopted for some but not all FSA and DCAP participants, subject to Section 125 non-discrimination rules.
  • Amounts available during an extended grace period will not be taken into account for the purpose of non-discrimination rules.

Terminated Participants

Previous Guidance (Section 214 guidance)

Allows Section 125 plan sponsors to allow health FSA participants who cease participation in the plan during calendar year 2020 or 2021 to continue to receive reimbursements from unused benefits or contributions through the end of the plan year in which such participation ceased, including any grace period and allowable modification of such grace period.

Clarifications

  • Plan sponsors may limit the unused amounts in a health FSA to the amount of salary reduction contributions the employee has made from the beginning of the plan year in which the employee ceased to be a participant up to the date the employee ceased to be a participant.
  • This option is available for an employee who ceases participation as a result of termination, change in employment status or a new election during calendar year 2020 and 2021.

Special Age Limit Relief

Previous Guidance (Section 214 guidance)

Allows plan sponsors to substitute age 14 for age thirteen 13 for purposes of determining dependent care assistance which may be paid or reimbursed during the last plan year with respect to which the end of the regular enrollment period for such plan year was on or before January 31, 2020 and in the case of an employee who has an unused balance in a dependent care assistance program for such plan year, the subsequent plan year. Regarding the subsequent plan year, this applies only to so much of the amounts paid for dependent care assistance with respect to the dependents and does not exceed the unused balance.

Clarifications

  • Only certain employees are eligible for this relief:
    • Any employee who is enrolled in DCAP for the last plan year with respect to which the end of the regular enrollment period for the plan year was on or before January 31, 2020 AND has one or more dependents who attain the age of 13 either during that plan year, or
    • In the case of the employee who has unused dependent care amounts for that plan year, during the subsequent plan year.
  • Employers may amend one or more of its cafeteria plan in accordance with these clarifications
  • Special age limit relief is separate from the general carryover and extended claims period relief. An employer that adopts the special age limit relief is NOT required to adopt the carryover or extended period in order to adopt the special age limit relief.
  • If this amendment is adopted, then all amounts from the most recent plan year with respect to which the end of the regular enrollment period was on or before January 31, 2020 may be applied to dependent care expenses for a dependent who attained age 13 during that plan year. IN addition, employers may allow employees to carry over all unused amounts from that plan year (the first plan year) to reimburse dependent care expenses during the subsequent plan year for a dependent that attained age 13 during the first plan year (until that dependent attains age 14) and for a dependent who attains age 13 during the subsequent plan year.
  • This special age limit relief for DCAP does not apply to any unused amount carried over from the subsequent plan year.
  • This relief also does not permit an employer to reimburse expenses for a child who is age 14 or older.

Section 125 Election Changes

Previous Guidance (Section 214 Guidance)

Allows plan sponsors to permit participants to make prospective mid-year election changes for health FSAs and DCAPs for plan years ending in 2021. The elections changes must be prospective and may be done without regard to a change in status.

Participants may:

  • Revoke an election, make one or more elections, or increase or decrease an existing election regarding health FSA
  • Revoke an election, make one or more election, or increase or decrease an existing election regarding DCAP

Clarification

  • Prospective election changes may include an initial election to enroll in health FSA or DCAP if employee initially declined to enroll in the health FSA or DCAP. An employer adopting this relief may limit the period during which election changes can be made.
  • With respect to health FSAs and DCAPS, plan sponsors are permitted to limit mid-year changes to amounts no less than amounts already reimbursed and to certain types of mid-year election changes, such as decreases in elections only.
  • Plan sponsors are permitted to allow mid-year election changes without a status change up to a certain date during the plan year, but require a status change after that date AND to limit the number of election changes during the plan year that are not associated with a status change.
  • This relief does NOT allow unused amounts to be paid to the employee in cash or paid to an employee in the form of any taxable or nontaxable benefit without regard to whether the employee incurs expenses during the period of coverage.
  • If health FSA or dependent care participation is revoked, the treatment of amounts previously contributed are subject to the terms of the plan, which must apply uniformly to all participants. The plan may provide that amounts contributed before the election is revoked remain available to reimburse expenses incurred for the rest of the plan year.
  • Alternatively, the plan may provide that if the election is revoked, amounts contributed before the revocation will be available only to reimburse eligible expenses incurred before the revocation takes effect (and not later expenses) or that the amounts before the revocation will be forfeited.
  • Plan sponsors may also amend the Section 125 plan to allow employees to:
    • Make a new election for employer sponsored health coverage (health, dental or vision) on a prospective basis, if the employee initially declined to elect employer sponsored health coverage (**would require special enrollment);
    • Revoke an existing election for employer sponsored health coverage and make a new election to enroll in different health coverage sponsored by the same employer on a prospective basis (**would require special enrollment);
    • Revoke an existing election for employer sponsored health coverage on a prospective basis, provided that the employee attests in writing that the employee is enrolled, or will immediately enroll, in other health coverage not sponsored by the employer. Employer may rely on the written attestation provided by the employee, unless the employer has actual knowledge that the employee is not, or will not be, enrolled in other comprehensive health coverage not sponsored by the employer.
  • Plan sponsors are not required to provide unlimited election changes and may determine the extent to which changes are permitted, provided that any permitted election changes are applied on a prospective basis only.
  • Any change to election requirements may not result in the failure to comply with the non-discrimination rules.
  • Plan sponsors should consider adverse selection and may wish to limit election to circumstances in which an employee’s coverage will be increased or improved as a result of the election change.
  • HSA NOTE: If the Section 125 plan provides that revocation of the health FSA election terminates participation, and no subsequent reimbursements will be available, the health FSA will no longer be treated as health coverage that disqualifies an otherwise eligible individual from contributing to the HSA. Similarly, if under the terms of the plan the health FSA reimburses only expenses incurred before the date of revocation, 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 months after the date of revocation and an otherwise eligible individual may begin contributing to an HSA.

Changes between HSA compatible and general purpose health FSAs

  • Plans may be amended to allow an employee to make a mid-year election to be covered by a general purpose FSA for part of the year and an HSA compatible health FSA for part of the year.
  • Plans may be amended to offer employees a choice between a HSA compatible health FSA or general purpose FSA during the period to which the 214 carry-overs or extended grace periods for incurring claims apply, on an employee-by-employee basis.
  • Plans may implement a plan design in which employees who elect an HDHP are automatically enrolled in an HSA-compatible health FSA.
  • To the extent any changes result in an employee being ineligible for an HSA mid-year on a prospective basis, the employee would not be rendered HSA ineligible for the earlier part of the plan year.
  • IF an employee begins the year with a general purpose FSA and then elects coverage by an HDHP and HSA compatible health FSA, the employee’s permissible HSA contribution is based on the number of months that the employee is an eligible individual.
  • Unused amounts in the general purpose FSA may be added to the HSA compatible FSA, but only expenses both allowed by the HSA compatible FSA and incurred during the months after the change in coverage may be reimbursed by the HSA compatible FSA.

COBRA

If an employer allows an employee who ceases to be a participant as the result of termination of employment or change in employment status to be reimbursed for expenses incurred after the termination or reduction in hours through access to the amount of salary reduction contributions that have been made as of the date the employee ceased being a participant, this event would constitute a COBRA qualifying event subject to notice requirements.

EXAMPLE: If an employee elected to contribute $2,400 to a health FSA, terminated employment on January 31 after making $200 in salary reduction contributions, and as a result of the termination was no longer permitted to contribute to the health FSA other than by electing COBRA continuation coverage, the employer may:

  • Allow the employee to request reimbursement for up to $200, or
  • The employee may elect COBRA continuation coverage to have access to $2,400 by paying the applicable COBRA premium of $200 per month on an after-tax basis.

Additionally, if an employer adopts a § 214 carryover or extended period for incurring claims, the maximum amount that a health FSA may require to be paid as the applicable COBRA premium does not include unused amounts carried over or available during the extended period for incurring claims. Thus, if a qualified beneficiary is allowed a § 214 carryover to a later plan year or an extended period for incurring claims, the applicable COBRA premium payable to provide access to the carryover amounts or the amounts attributable to the extended period for incurring claims for that later year or for the extended period for incurring claims is zero.

An employer is not required to allow individuals who cease participation in the plan to continue to receive reimbursements from unused benefits in a health FSA if the individual does not qualify for and elect COBRA continuation coverage. An employer is not obligated to amend its plan to make the relief permitted available to all employees. Instead, employees for whom the extension of coverage is unavailable remain eligible to elect COBRA, as do employees for whom the extended coverage is available.

Plan Amendments

If an employer decides to adopt any of these changes, the employer must adopt a plan amendment.  Any amendment can be applied retroactively.

Amendments 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 effective and the plan or arrangement is operated consistent with the terms of the amendment during the period beginning on the effective date of the amendment and ending on the date the amendment is adopted.

W2 Dependent Assistance

Only the actual election amount of the year is reported on the W2 and does not include any amounts carried over or available during an extended grace period.

OTCs and Menstrual Care Products

Health FSAs and HRAs may be amended to provide for reimbursements of expenses for menstrual care and over the counter drugs without prescriptions for any period beginning on or after January 1, 2020.

Key Takeaways

These clarifications from the Internal Revenue Service (IRS) are designed to help organizations understand their temporary options regarding tax-advantaged flexible spending arrangements and Section 125 election changes.

Organizations would be advised to thoroughly review these clarifications and make modifications that make sense for your unique needs in conjunction with your Third Party Administrator (TPA).

If you have specific questions or concerns, please reach out to your M3 Account Team or your TPA.

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