IRS Clarifies FSA Options and Offers Additional Flexibilities

The Taxpayer Certainty and Disaster Tax Relief Act of 2020, recently enacted as Division EE of the Consolidated Appropriations Act, 2021, included Section 214 offering employers new options related to flexible spending accounts (FSAs) for health care and dependent care expenses.  IMA summarized these changes here on January 6, 2021, but as a quick recap, employers could decide whether to allow any/all of the following:

• § 214(a): A carryover of more than $550 (or adding a carryover if they didn’t already have one) from 2020 to 2021
• § 214(b): A carryover of more than $550 from 2021 to 2022
• § 214(c)(1): A grace period of up to 12 months from 2020 to 2021 and from 2021 to 2022
• § 214(c)(2): A health FSA may allow someone who ceased participating during calendar year 2020 or 2021 to continue being reimbursed the rest of the plan year in which they stopped participating (plus any normal or extended grace period) without COBRA
• § 214(d)(1) Special reimbursement of dependent care expenses past a child’s 13th birthday for the 2020 plan year (if enrolled in the daycare FSA during the annual open enrollment that ended by January 31, 2020)
• § 214(d)(2): For those who met the criteria for § 214(d)(1), a special carryover to 2021 of funds still remaining after reimbursing age 13 expenses for 2020, with those carryover funds specifically allowed to be used until the day before that child turns 14, and for another child that turns 13 that plan year
• § 214(e): An FSA election change opportunity without a qualifying event for plan years ending in 2021
• Note: Plan amendments must be adopted no later than the end of the calendar year after the year in which the amendment is to be effective (so calendar year plans offering retroactive changes to their plan year ended 12/31/20 must adopt amendments by 12/31/21)

On Thursday, February 18, 2021, the IRS issued clarifying guidance in IRS Notice 2021-15 with more details for implementing these § 214 options, along with extending a couple of additional provisions employers can also have available to them.  Always keep in mind that none of these provisions allows employees to just cash out their flexible spending accounts.  At the end of the day, valid claims must still be submitted for reimbursement.

New Option: 2021 Health Plan Election Change Without a Qualifying Event

First, we note the IRS is allowing employers the option to have employees change their medical, dental, and vision plan elections in 2021 without a qualifying event (the IRS had allowed this in Notice 2020-29 last year, but it didn’t extend into 2021). An employer interested in offering this should first get approval from their insurer or stop loss insurer.  Once approval is secured, the employer could offer one or more of the following:

• Allow an employee who had declined coverage for 2021 to newly enroll (coverage is not retroactive),
• Allow an employee to change their election for the remainder of 2021 (such as changing plans or adding dependents, but the changes are not retroactive), or
• Allow an employee to revoke their election for the remainder of 2021 (also not retroactive, and would require the employee to attest to having or immediately securing comprehensive coverage elsewhere…a model attestation is provided, and the employee must attest to replacing with the correct type of coverage – i.e., they cannot revoke medical coverage by attesting to enrollment in coverage solely for dental or vision benefits)

Similar to how this worked in 2020, employers may limit the period during which election changes may be made.

New Relief: More Time to Make Retroactive OTC Amendments

Next, we note the IRS is allowing extra time to make amendments to health FSAs (and HRAs if they’re impacted) to allow reimbursement of over-the-counter medications without a prescription and menstrual products retroactive to January 1, 2020.  The CARES Act allows these to be eligible expenses for reimbursement retroactively to January 1, 2020, but hadn’t explicitly granted extra time past 2020 to adopt amendments.  Now employers that were unable to get those amendments in place in 2020 have extra time.

Clarifying Guidance on the New Section 214 Options

Finally, we get into the clarifications of the § 214 FSA flexibilities offered in the Consolidated Appropriations Act, 2021.  Note that an employer may exercise any available amendments with respect to each type of FSA they sponsor, and can adopt different provisions for their different FSAs (such as one set of changes or no changes to their health FSA, another set of changes or no changes to their LPFSA, and yet another set of changes or no changes to their daycare FSA).

§ 214(a) and (b) Enhanced Carryover Guidance

• An employer may provide a carryover of all or part of the unused amounts remaining in a health FSA, limited purpose FSA (LPFSA), and/or daycare FSA as of the end of a plan year ending in 2020 or 2021 to the immediately subsequent plan year.
  • This is available even if they didn’t have a carryover already, or if they have a grace period which they’d like to convert to a carryover instead.
• The employer may limit the carryover to fewer than 12 months.
• For employers with plan years or grace periods ending in 2020 that exercised their option in IRS Notice 2020-29 to extend a grace period through December 31, 2020, all amounts made available during that extended grace period that remain unused as of December 31, 2020, are available for carryover.
• An employer adopting a § 214 carryover is permitted to require employees to enroll in the health FSA or daycare FSA with a minimum election amount in order to have access to carryover funds.
  • If an employer adopts both the § 214 carryover from the 2020 calendar year to 2021 and the flexibility to make a mid-year FSA election change, and an employee thus elects to newly participate in the FSA for the remainder of 2021, the § 214 carryover amount may be made available to reimburse employee expenses retroactive to January 1, 2021.
• An employee enrolled in a health savings account (HSA) with a high deductible health plan (HDHP) will be considered to have disqualifying coverage if funds are carried over to a health FSA.  To help alleviate this, employers may amend their plan to allow employees, on an employee-by-employee basis, to opt out of the carryover, to make a mid-year election to be covered by a LPFSA for the carryover, or to be automatically enrolled in a LPFSA for the carryover when enrolled in an HSA/HDHP.
  • Employers have long been allowed to offer several options since 2014 to help employees remain HSA eligible when a carryover might be present.
  • But if the employer had not adopted one or more of these options, there’s now a chance to adopt an allowable change retroactively.

§ 214(c)(1) Extended Grace Period Guidance

• An employer may extend its existing grace period it already had, convert its carryover to a grace period, or offer a new grace period, lasting up to 12 months.
  • The law was worded that an employer could only “extend” a grace period, so it was unclear whether that meant an employer could adopt a “new” grace period or could only extend an already existing grace period.
• Employers may amend their health FSA to allow employees, on an employee-by-employee basis, to opt out of any extended grace period, to make a mid-year election to be covered by a LPFSA for the grace period, or to be automatically enrolled in a LPFSA for the grace period when enrolled in an HSA/HDHP.
  • This is not typically allowed.  So this is a new one-time allowance.
  • Ordinarily, the employer’s only option since 2005 has been to convert all employees’ health FSA grace periods to LPFSA grace periods (including those who do not enroll in the HSA/HDHP).
• The employer may limit the grace period to fewer than 12 months. But if the employer extends the grace period to 12 months, then all funds unspent at the end of the plan year are available to extend to the next grace period.
  • Ordinarily, grace period funds unspent by the end of the 2.5-month grace period (and subsequent run-out period) are forfeited.  But this is because a grace period usually doesn’t last to the end of the plan year.
  • In this case, however, if the grace period lasts to the end of the plan year, then those funds don’t have to be forfeited if that plan year is then followed by a grace period or carryover provision.

§ 214(d) Special Rules for Dependent Care Expenses Past Age 13

• This provision is optional and is separate from the carryover and grace period provisions above.
• Should the employer decide to adopt this provision, it will be important to pay attention to the details, as it is only for very specific individuals in very specific circumstances.
  • This provision is limited to just those employees who enrolled in the daycare FSA during the regular annual open enrollment period that ended by January 31, 2020
    • It is not available to those who fist enrolled after such open enrollment period had closed, such as due to marriage, birth, or adoption
  • Of those employees, this provision would only allow those who had funds left unspent at the end of that plan year to:
    • Reimburse themselves for dependent care expenses through the end of that plan year on a child that had turned 13 during that plan year, and
    • Carryover all still remaining funds to the immediately subsequent plan year, but these carried over funds would only be available to reimburse the employee for dependent care expenses on that same child through the end of the day before they turn 14 and for another child they have that turns 13 during that plan year

§ 214(e) FSA Election Changes Without a Qualifying Event

Similar to how this worked under IRS Notice 2020-29, the employer may:

• Limit the period of time during which an election change may be made (e.g., submit changes by March 31, 2021)
• Limit the number of times an election may be changed without a qualifying event (e.g., only allow one change without a qualifying event reason)
• Restrict the type of election change allowed (e.g., an employer might want to permit new enrollments or decreases only if carryover or grace period funds become newly available)
• Impose limits so employees must pay into the plan at least as much as they’ve already been reimbursed for submitted claims
• Decide whether to treat amounts contributed before revoking coverage as either subject to the usual run-out period and then forfeited, or able to be used on expenses the rest of the plan year (and any subsequent grace period).
  • If allowing extra time to incur health care claims would disqualify someone from an HSA, the employer could allow the employee an option to decline the extension of time.  This employee would only have a run-out period to submit receipts for claims incurred while still enrolled in the health FSA, making the active FSA months the only months they had disqualifying coverage blocking HSA eligibility.
• Decide whether to allow revocations to be for a future date (e.g., if the employee wants to keep paying into the plan for two more months and then have coverage end April 30, but the employer’s deadline to submit their election change is March 31).

Election changes cannot be retroactive.  However, if someone enrolls for the first time under this provision (perhaps because funds have been made newly available under a carryover or grace period that requires them to elect a minimum amount for the new year, or perhaps they have had a change in circumstances that isn’t a qualifying event so they’d like to enroll now), the employer could permit them to submit claims for reimbursement retroactive to the start of the plan year that began on/after January 1, 2021.

§ 214(c)(2) Extended Time to Incur Health FSA Expenses After Termination

We left this one for last (and thus out of order from the list above) as it’s not likely to be overly relevant to most employers.

Some employers may be interested in the option to allow employees the rest of the plan year (plus any normal or extended grace period) to incur claims for reimbursement by the health FSA after termination without having to elect and pay for COBRA.  The employer can limit what’s available under this provision so the employee can only be reimbursed valid claims to the amount the employee has already contributed.  If an employer adopts this provision for terminating employees or a class of terminating employees, the employer is still obligated to provide the COBRA notice for underspent FSAs, since they can have access to the entire annual election amount.

If an employer is not interested in this and will only offer COBRA for underspent health FSAs subject to the individual paying a premium, the IRS reminds employers that COBRA premiums can no longer be charged for the health FSA once the current plan year closes and the beneficiary enters a grace period.  This is often a reason why employers will insist on a minimum health FSA election amount in the new year in order to have access to grace period funds…it helps avoid the need to offer a grace period to health FSA beneficiaries on COBRA.

IMA will continue to monitor regulator guidance and offer meaningful, practical, timely information.

This material should not be considered as a substitute for legal, tax and/or actuarial advice. Contact the appropriate professional counsel for such matters. These materials are not exhaustive and are subject to possible changes in applicable laws, rules, and regulations and their interpretations.