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Houston Harbaugh Blog

New Stimulus Law Permits Additional Cafeteria Plan Flexibility

Generally, the rules governing Section 125 cafeteria plans require that an employee’s benefit elections be irrevocable throughout each plan year, absent a change in the employee’s status (marriage, divorce, birth of a child, etc.) or significant changes in the cost of coverage during the year. In addition, the “use it or lose it” rule requires that amounts remaining in employees’ Health and Dependent Care Flexible Spending Accounts (FSAs) at the end of each plan year be forfeited by the employee, subject to a couple of limited exceptions.

The coronavirus pandemic has made it more difficult for employees to budget their families’ health care and dependent care needs, and to effectively spend down balances in FSAs. In response, guidance issued by the IRS on May 12, 2020 (Notice 2020-29, see Houston Harbaugh’s previous article here) provided substantial flexibility to change cafeteria plan elections during 2020, as well as extended grace periods for spending unused amounts in both Health and Dependent Care FSAs. The new stimulus law signed by President Trump on December 27, 2020 (the Consolidated Appropriations Act, 2021, referred to in this bulletin as the “CAA”) provides additional opportunities for flexibility in cafeteria plan administration.

As with the 2020 IRS notice, the changes made available by the CAA are optional; employers may elect to incorporate any or all of the available changes into their plans, or they may elect to continue to administer their cafeteria plans by applying traditional rules. A summary of the available changes follows. In each case, a description of the general rule, the changes permitted by the 2020 IRS notice, and the changes permitted by the CAA are included.

Mid-Year Elections:

General Rule. Employees are not permitted to change their cafeteria plan elections during a plan year, absent a change in status or the cost of coverage.

2020 IRS Notice. During the 2020 calendar year, and if permitted by the employer, employees were allowed to change their salary reduction elections with respect to (a) employer-sponsored health coverage, (b) Health FSAs, and/or (c) Dependent Care FSAs, on a prospective basis.

New CAA Rule. During plan years ending in 2021 (e.g., the 2021 calendar year for a plan that operates on the calendar year), and if permitted by the employer, employees are allowed to change their salary reduction elections with respect to (a) Health FSAs, and/or (b) Dependent Care FSAs, on a prospective basis. (Unlike the 2020 IRS notice, the CCA does not permit changes with regard to employer-sponsored health coverage.)

Grace Periods:

General Rule. As an exception to the “use it or lose it” rule, the “grace period” rule permits a participant to apply unused amounts (including amounts remaining in a Dependent Care FSA as well as a Health FSA) at the end of a plan year to pay expenses incurred for those same benefits during a period of up to two months and 15 days immediately following the end of the plan year (e.g., through March 15 for a cafeteria plan operating on the calendar year).

2020 IRS Notice. A cafeteria plan could be amended to permit employees to apply unused amounts remaining in a Health FSA or a Dependent Care FSA as of the end of a grace period ending in 2020 to pay or reimburse medical care expenses or dependent care expenses, respectively, incurred through December 31, 2020. As an example, the grace period for a cafeteria plan for the 2019 calendar year expired March 15, 2020 under the normal rules. Under the 2020 IRS notice, the plan could be amended to permit employees to apply any unused amounts to expenses incurred on or before December 31, 2020.

New CAA Rule. Employers may amend their plans to expand the normal 2½ month grace period to 12 months, effective for plan years ending in 2020 or 2021. For a cafeteria plan operating on the calendar year, this means that the grace period for 2020 can be extended to December 31, 2021, and the grace period for 2021 can be extended to December 31, 2022.

Carryovers:

General Rule. As a separate exception to the “use it or lose it” rule, the “carryover” rule allows a cafeteria plan to permit unused amounts remaining in a Health FSA at the end of a plan year to carry over to the following plan year, to pay or reimburse a participant for medical care expenses incurred during such following plan year, subject to the carryover limit (currently $550). This exception is not available with regard to Dependent Care FSAs. With regard to Health FSAs, a cafeteria plan may include the grace period rule, the carryover rule, or neither rule, but may not include both rules.

2020 IRS Notice. A cafeteria plan could be amended to permit employees to apply unused amounts remaining in a Health FSA or a Dependent Care FSA at the end of a grace period or plan year ending in 2020 to pay or reimburse medical care expenses or dependent care expenses, respectively, incurred through December 31, 2020. As an example, the grace period under a cafeteria plan for the 2019 calendar year expired March 15, 2020 under the normal rules. Under the 2020 IRS notice, the plan could permit employees to apply any unused amounts to expenses incurred on or before December 31, 2020. (Note: Because of the wording of the effective date provision in the 2020 IRS notice, this relief was available to plans with grace periods and plans that did not operate on the calendar year, but was not available to a calendar year plan with no grace period.)

New CAA Rule. Employers may amend their plans to allow employees to carry over all unused amounts in an FSA from a plan year ending in 2020 to a plan year ending in 2021 and from a plan year ending in 2021 to a plan year ending in 2022. For example, in the case of a cafeteria plan operating on the calendar year, a December 31, 2020 FSA balance could be spent as late as December 31, 2021, and a December 31, 2021 FSA balance could be spent as late as December 31, 2022. This rule is not subject to any dollar limit, and applies to Dependent Care FSAs as well as Health FSAs.

Post-Termination Expenses:

General Rule. Employees whose participation in the cafeteria plan ends (e.g., due to termination of employment) have been able to use amounts remaining in their Dependent Care FSAs to pay for dependent care expenses incurred later in the plan year, but this opportunity was not available with respect to Health FSAs.

2020 IRS Notice. The 2020 IRS notice did not include any changes in this area.

New CAA Rule. Employers may amend their plans to allow employees who terminate participation during either of the 2020 or 2021 calendar years to spend down unused Health FSA balances through the end of the plan year containing the date of termination (similar to what is already permitted for Dependent Care FSAs). Expenses incurred during a grace period applicable to the particular FSA for one of these years (including extensions provided under the CAA) may also be used to exhaust the FSA.

Dependent Care Age Limit:

General Rule. Reimbursements for child care from a Dependent Care FSA are limited to expenses incurred with respect to children who are under age 13.

2020 IRS Notice. The 2020 IRS notice did not include any changes in this area.

New CAA Rule. Employers may amend their plans to temporarily increase the age limit for qualified dependent care expenses. More specifically, a participant in a Dependent Care FSA can continue to receive reimbursements for a child’s dependent care expenses for the remainder of a plan year after the child’s 13th birthday (provided that the enrollment period for the plan year ended on or before January 31, 2020) and, if there were unused amounts in that plan year, continue to use any balance remaining during the following plan year until the child’s 14th birthday. This rule is only available to a participant who (a) was enrolled in the Dependent Care FSA for the last plan year with respect to which the regular enrollment period ended on or before January 31, 2020 (e.g., the 2020 plan year for a calendar year plan), and (b) has a child who attains age 13 in that plan year (and if there were unused elected amounts in that plan year, in the next plan year).

Plan Amendments and Employee Communications:

As stated above, all of the changes described above are optional; an employer is permitted, but not required, to make these changes to its particular cafeteria plan. An employer is also permitted to adopt some, but not all, of the available changes. Many employers will want to provide maximum flexibility to their employees. However, increased flexibility for employees could result in increased costs for employers, as lesser forfeitures will be available to offset those costs. The accompanying 2021Cafeteria Plan Amendment Checklist can be used by an employer to indicate the changes the employer wishes to include in its plan amendment.

The CAA permits employers to implement desired changes in operation, and to amend their cafeteria plans as late as December 31, 2021 for changes affecting plan years ending in 2020 and as late as December 31, 2022 for changes affecting plan years ending in 2021. However, these changes are of course helpful to employees only if they are made aware of their availability. Therefore, adoption of plan amendments and distribution of employee communications (e.g., updated Summary Plan Descriptions and/or employee notices) are suggested as soon as possible.

Please contact Gary Gunnett at (412) 288-2210 or [email protected] with any questions on any of the above.

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