On May 12, 2020, the IRS released Notices 2020-29 and 2020-33 which are intended to help taxpayers address unanticipated health and dependent care expenses due to the COVID-19 pandemic. Under this collective guidance, employers have the option to amend their section 125 cafeteria plans and flexible spending accounts (FSAs) to allow employees to make prospective midyear election changes, regardless of the reason, during calendar year 2020.
The general rule is employee elections for pretax payment of employer-sponsored health coverage, health FSAs and dependent care assistance programs must be made prior to the first day of the plan year. They also must be irrevocable for the plan year unless the employee experiences a permitted change in status or there are significant changes in the cost of coverage. This requirement includes an affirmative election to participate or a default election not to participate.
An employer may amend its section 125 cafeteria plan to allow employees to:
An employer may amend its section 125 cafeteria plan to permit employees to apply unused amounts remaining in a health FSA or dependent care assistance program at the end of the grace period or end of the plan year to pay or reimburse medical care expenses or dependent care expenses through Dec. 31, 2020.
For example, if a calendar-year health FSA provided for a 2 ½ month grace period following its 2019 plan year, the employer could amend the plan to provide that any unused amounts in the health FSA as of March 15, 2020 (the last day of the grace period) could be used to pay or reimburse the employee for healthcare expenses incurred through Dec. 31, 2020. Similarly, a health FSA with a non-calendar plan year ending in 2020 that allows for a $500 carryover could be amended to allow any unused amounts (including amounts greater than $500) to be used to pay or reimburse health expenses incurred during the remainder of the 2020 calendar year.
This relief applies to all health FSAs, including limited purpose health FSAs compatible with health savings accounts (HSAs). However, an employee who had unused amounts remaining at the end of the plan year or grace period ending in 2020 and who is allowed an extended period to incur expenses under a health FSA will not be eligible to contribute to an HSA during the extended period, unless the health FSA is a limited purpose health FSA compatible with an HSA.
The maximum unused amount remaining in a health FSA from a plan year beginning in 2020 allowed to be carried over to the immediately following plan year beginning in 2021 is $550. However, for the 2019 plan year and amounts carried over into 2020, the limit remains $500.
An employer that elects to provide the additional flexibility regarding midyear election changes, or to provide additional time to apply unused amounts in a health FSA or dependent care assistance program to pay or reimburse expenses for the remainder of the 2020 year, must adopt a plan amendment to allow the change to its plan. Any amendment for the 2020 plan year can be adopted as late as Dec. 31, 2021, and may be effective retroactively to Jan. 1, 2020, provided that the plan operates in accordance with the requirements of the notices, and the employer notifies all plan participants of the changes to the plan.
Prior IRS guidance permitted plans to cover any COVID-19-related services at no cost without affecting HSA eligibility. Notice 2020-29 provides three points of clarification:
Please reach out to your Baker Tilly tax advisor to discuss how these changes may affect your tax situation.
The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.