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IRS provides COVID-19 flexibility for section 125 cafeteria plans and high deductible health plans

Authored by Christine Faris, Paul Dillon, Michelle Hobbs and Devin Tenney

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.

Background

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.

Key takeaways

  • Employers can modify plans to allow employees to make prospective midyear elections for health coverage, health FSAs and dependent care assistance programs.
  • Claim periods for taxpayers to apply unused amounts remaining in a health FSA or dependent care assistance program for expenses incurred for those same qualified benefits are extended through Dec. 31, 2020.
  • The permitted carryover amount for health FSAs is increased to $550 from $500.
  • Previously provided temporary relief for high deductible health plans (HDHPs) may be applied retroactively to Jan. 1, 2020.
  • An employer electing to provide this midyear election flexibility, or allow additional time to apply unused amounts in a health FSA to pay or reimburse expenses for the remainder of the 2020 year, must adopt a plan amendment documenting the change to its plan. Any amendment for the 2020 plan year can be adopted as late as Dec. 31, 2021.

Employee election revisions under section 125 cafeteria plan allowed

An employer may amend its section 125 cafeteria plan to allow employees to:

  1. Make a new election for employer-sponsored health coverage on a prospective basis, if the employee initially declined to elect employer-sponsored health coverage;
  2. 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 (including changing enrollment from self-only coverage to family coverage);
  3. 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 immediately will enroll, in other health coverage not sponsored by the employer;
  4. Revoke an election, make a new election, or decrease or increase an existing election regarding a health FSA on a prospective basis; and
  5. Revoke an election, make a new election, or decrease or increase an existing election regarding a dependent care assistance program on a prospective basis.

Extended claim periods

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.

Permitted carryover amount increased

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.

Plan amendments

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.

Retroactive HDHP/HSA relief

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:

  1. Guidance was applicable on a retroactive basis to Jan. 1, 2020,
  2. Coverage for any COVID-19 testing or supply services required to be covered at no cost under the Families First Coronavirus Response Act and Coronavirus Aid, Relief, and Economic Security (CARES) Act will not influence HSA eligibility, and
  3. Plans that provide free telehealth services (whether COVID-19-related or not) will not impact HSA eligibility through Dec. 31, 2020, and will be applied retroactively to Jan. 1, 2020.

Please reach out to your Baker Tilly tax advisor to discuss how these changes may affect your tax situation.

Contact our COVID-19 support team

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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.

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