IRS Provides Cafeteria Plan Relief Related To COVID-19

On February 18, 2021, the Internal Revenue Service (IRS) issued Notice 2021-15 (Notice), providing additional flexibility to employers who offer health flexible spending arrangements (Health FSAs) or dependent care assistance programs (DCAPs aka Dependent Care FSAs).

A Health FSA and DCAP offered under a Section 125 cafeteria plan (Section 125) allow employees to set aside pre-tax wages to reimburse qualified medical or dependent care expenses, respectively.  As a result of the COVID-19 public health emergency, many employees have unused amounts in these arrangements left over at the end of the plan year. Typically, funds remaining at the end of the plan year are forfeited under the “use it or lose it” rules applicable to Health FSAs and DCAPs.

However, the Notice allows employers to amend existing Section 125 plans^[1]  to provide additional flexibility during the 2020 and 2021 plan years for employees to make use of these funds.

Specifically, the Notice addresses the following issues: (1) the temporary special rules relating to Health FSAs and DCAPs; (2) mid-year election changes related to employer-sponsored health coverage; and (3) plan amendments necessary to provide for the specific forms of relief described herein.

The Notice also references the expansion of reimbursements for over-the-counter drugs (OTCs) without prescriptions and menstrual care products.

Temporary Special Rules Related to Health FSAs and DCAPs

Employers have discretionary authority to amend their Section 125 plan document in order to provide certain relief to employees, which may include the following:

1. Either extend the applicable grace period^[2] (grace period relief) or expand the carryover amount^[3] (carryover relief)^[4] in order to allow employees to carry over some or all unused FSA and DCAP^[5] amounts from a plan year ending in 2020 or 2021 to the immediate next plan year^[6];
2. Allow employees who cease participation^[7] in a plan during the plan year to spend down unused FSAs and DCAPs benefits after ceasing their participation^[8];
3. Expand DCAP coverage to dependents who are 13 years of age, rather than 12 years of age (DCAP age
   relief), and to establish a special carryover rule for unexpended funds related to such dependent care to the following plan year^[9]; and
4. Allow employees to make certain mid-year election changes for FSAs and DCAPs for plan years ending in 2021, including revoking elections, increasing or decreasing salary reduction contributions, and making new elections, regardless of whether the basis for such election change satisfies the generally applicable IRS election change requirements^[10] (FSA election relief) and allow employees to use amounts contributed to an FSA or DCAP after a revised election for qualified expenses incurred prior to the election change.^[11]

Mid-Year Elections to Change to Employer-Sponsored Health, Dental and/or Vision Coverage

An employer also has discretionary authority to allow employees to make mid-year election changes to their coverage under employer-sponsored health, dental, and vision plans (Health coverage election relief).^[12]

If the employer amends its Section 125 plan to allow for such mid-year elections, employees may change their coverage, according to the plan, as follows: (1) to elect coverage under an employer-sponsored plan if the employee was not previously covered; (2) to revoke an existing election and elect a different employer-sponsored plan; or (3) to revoke existing employer-sponsored coverage entirely, so long as the employee revoking such coverage attests in writing that they are enrolled in or will immediately enroll in another health plan not sponsored by the employer. Relatedly, the Notice provides sample attestation language that employers may use and rely upon when an employee is revoking their employer-sponsored coverage entirely.

Employers who offer this flexibility may want to consider limiting the number of election changes an employee may make or limiting the circumstances under which an employee may make an election change, such as to only allow a change if it would improve the employee’s coverage.

Section 125 Plan Amendments

In order to take advantage of the flexibility offered by the IRS Notice, an employer must adopt an amendment to its Section 125 Plan.^[13]  In order for such plan amendments to provide relief retroactively, the employer must adopt the amendment 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 employer must operate such plan in accordance with the amendment at all times beginning on the effective date of such amendments.

This generally means that any Section 125 Plan amendment should be adopted by December 31, 2021, in order for the flexibility to apply retroactively to 2020 and 2021. Employers with a non-calendar plan year may have additional time.

Expansion of Reimbursable Expenses

Lastly, FSAs and Health Reimbursement Accounts (HRAs) can now reimburse participants for menstrual care products and over-the-counter drugs (OTCs) as qualified medical care expenses if incurred after December 31, 2019.

Employers should ensure that the definition of qualified medical care expenses in their 125 Plan includes this expanded definition.

^[1]. 26 U.S.C. § 125.

^[2]. Under generally applicable rules, where a cafeteria plan provides for a grace period, a participant may apply unused amounts of a health FSA at the end of a plan year in order to pay for expenses incurred during the two months and 15 days immediately following the end of the plan year (grace period rule). (See Notice 2005-42, 2005-1 C.B. 1204, and Prop. Treas. Reg. §1.125-1(e).)

^[3]. Under generally applicable rules, where a cafeteria plan provides for a carryover, a participant may carry over the unused amounts, subject to the statutory limit (e.g., $550 in 2020), remaining in a health FSA at the end of a plan year in order to pay or reimburse a participant for medical care expenses incurred during the immediate subsequent plan year (carryover rule). (See Notice 2013-71, 2013-47 IRB 532, and Notice 2020-33, 2020-22 IRB 868)

^[4]. Under generally applicable rules, a cafeteria plan may either: (1) permit a participant to carry over the unused amounts remaining in a health FSA at the end of a plan year in order to pay or reimburse a participant for medical care expenses incurred during the immediate subsequent plan year, subject to the carryover limit (carryover rule).; or (2) permit a participant to apply the unused amounts (including DCAP) at the end of a plan year in order to pay for expenses incurred during the two months and 15 days immediately following the end of the plan year (grace period rule)

^[5]. Under generally applicable rules, a cafeteria plan may not provide for a DCAP carryover.

^[6]. See Notice 2021-15, Sec. III, Subs. A., pp. 5-9. As a practical matter, in most cases, the temporary extension of the grace period and expansion of carryover limits provide the same relief. However, specific relief available to participants may vary because of the differences in how each type of relief interacts with the extended period for incurring certain claims. (See Notice 2021-15, Sec. C., pp. 12-16.)

^[7]. A participant may cease participation in a plan due to termination of employment, a change in employment status, or a new election.

^[8]. See Notice 2021-15, Sec. III, Subs. B, pp. 9-12. Under generally applicable rules, an employee who ceases participation in the plan during the calendar year may not receive reimbursements from unused health FSAs benefits or contributions after the end of their participation. The Notice provides that the plan may limit the provision of reimbursements after the participant ceases participation to the participant’s salary reductions prior to the date participation ceased. The Notice further provides how the post-participation spend-down interacts with the Consolidated Omnibus Budget Reconciliation Act (COBRA). (See Notice 2021-15, Sec. III, Subs. G, 28-30.)

^[9]. See Notice 2021-15, Sec. III, Subs. D, pp. 16-19. The Notice also provides that plans may adopt this special age revision without adopting either the carryover or grace period plan revisions.

^[10]. See Notice 2021-15, Sec. III, Subs. E, pp. 19-26. Under generally applicable Treasury regulations, election changes are permitted only for certain reasons. (26 C.F.R. § 1.125-4.)

^[11]. Notice 2021-15, Sec. III, Subs. E, p. 23.

^[12]. Notice 2021-15, Sec. III, Subs. E, pp. 20-24. Similar relief is provided in Notice 2020-29.

^[13]. See Notice 2021-15, Sec. IV., pp. 33-34.