IRS Clarifies and Expands COVID Relief

In response to the COVID crisis, the Consolidated Appropriations Act of 2021 provided employers the ability to offer greater flexibility to employees with health FSA and Dependent Care FSA plans. While the flexibility was welcome news for plan participants, for employers, the Act brought with it two things of note:

  1. Additional administration complexities
  2. Unanswered questions and ambiguities

In an effort to address the unanswered questions, the IRS recently issued Notice 2021-15. The Notice provides important clarity for employers regarding the new flexibility available under FSA plans. However, in the process of proving that clarity, the notice doubled-downed on the administrative complexities required of employers and plans.

Choices, Choices, Choices

The notice is chock full of “clarifications” which actually create significant administrative and compliance burdens for employers (and their FSA plan administrators). This reality calls into question whether it is even remotely cost effective to offer the flexibility to participants given the nuanced requirements to assure compliance with the newly clear rules. In addition, all of these relief measures are temporary, so any investment in systems (by FSA administrators) to administer the plan flexibility in a compliant fashion would be lost when FSA plan rules revert back to pre-COVID days.

When the CAA was passed, FSA plan administrators generally “sucked up” the cost of administering those changes for employers. In light of the nitty gritty compliance required, it is likely that additional charges will be levied by FSA plan administrators for those employers electing to offer additional flexibility to employees.    

There is also the issue that once temporary plan relief is offered to employees, it becomes difficult to both communicate and manage expectations when plans revert back to their regular, less-flexible state in the future.

Employers will need to review the permissive flexibility offered and make decisions about whether to implement changes or not.

The Short Summary

Essentially all of the relief and plan flexibility measures have been further extended. This includes three main areas:

  • FSA Plan Flexibility:  Carryover and grace period relief is extended to plan years ending in 2021. Dependent care age is extended in certain circumstances. Post termination spend downs can be allowed. New retroactive eligibility allowed for mid-year changes.
  • HSA Issues: Clarification that certain FSA relief measures may have an adverse impact on participants making HSA contributions.
  • Health Plan Mid-Year Elections: Extension of prospective changes to health, dental, and vision plans.
  • Plan Amendments: Allows employers additional time for plan amendments.

The relief offered empowers employers to add significant flexibility to their health plans, and specifically FSA plans. These changes can benefit plan participants, however, they can add significant administrative complexity to the plan and require considerable employee education to enable understanding of the nuances.

What’s Actually New?

There are two new expansions to the FSA plan flexibility that employers can offer employees in the new IRS Notice:

  1. Post Termination FSA Reimbursements: This allows for reimbursement of claims incurred after termination up to the Plan Year to date contribution amount (without electing COBRA). This effectively suspends the Use-it-or-Lose it rule.
  2. Mid-Year Election Changes: This allows for open access to mid-year election changes for medical, dental, and vision plans.

These are the two truly new provisions. However, it does bear repeating that the most frequently asked question from the CAA is, “Can we really do rollovers for dependent care plans?” To reiterate, the answer is, “Yes” for this temporary period.

What’s Actually Not New?

Much of Notice 2021-15 does not offer anything new. Rather, it adds significant clarity to what was otherwise bare-bones legislation.

Over the course of the last several months since the CAA was passed, employers, advisors, and administrators alike have faced the realities of the lack of clarity and the complexities in administering what we know to be well-intended legislation to support plan participants in difficult times. However, the reality that has unfolded is a bit challenging from the perspective of airtight plan compliance. In the descriptions below, we have highlighted in italics some of these administrative complexities.

$100 Note with Mask

FSA Plan Flexibility

Carryover: Employers, at their discretion, may amend their §125 Plan to allow for a carryover of all or part of the unused balance remaining in a health FSA or dependent care FSA as of the end of a plan year.

  • This applies to plan years ending in 2020 (carried over to 2021) and to plan years ending in 2021 (carried over to 2022).
  • Employees may be required to enroll in the FSA with at least a minimum election amount to have access to unused amounts from a prior plan year. (Most FSA administrators currently do not have the ability to track this.)
  • This provision is optional, and employers may limit carryover amounts or the period during which carryovers can be used. (Limiting the period in which carryovers can be used is also something many FSA administrators do not have the ability to administer.)
  • This applies to regular health FSAs, HSA-compatible FSAs, and dependent care FSAs. (Dependent care “rollovers” are not allowed under traditional FSA rules, thus that functionality is not built into most systems.)
  • Applies to plans with a regular $550 rollover provision and/or to plans that do not currently include a rollover provision.  
  • Employers may offer participants the ability to opt out of a carryover in order to preserve HSA eligibility. (If a rollover is offered, the consequence of not opting out should be communicated to employees currently contributing to an HSA . . . which is not an easy task. Processing such an opt out is likely to require manual processing by most FSA administrators.)
  • Funds may be rolled over to an existing Limited Purpose FSA without impacting HSA eligibility.
  • Alternatively, employers may allow employees to make a mid-year election change and flip their health FSA from a Limited Purpose FSA to a general purpose FSA for a portion of the year and, presumably, flip it back as well. (Generally, the flipping process is done upon reaching the statutory deductible, not at a point selected by the individual. Most systems are not programmed to allow mid year flipping such as this and will require manual intervention.)   
  • Amounts carried over are not included in calculations for discrimination testing. (This will require differentiated reporting of carryover balances vs. current contribution balances for testing purposes.)
  • As with all plan provisions, notification of plan changes to employees is required. (Employee education and communication of these plan nuances is not an insignificant endeavor.)
  • The Notice lacks clarity about whether dependent care amounts rolled over that exceed the $5,000 annual cap (in the subsequent plan year) are taxable to employees. In a notable deviation, the guidance does clarify that health FSA rollover amounts do not impact the maximum election amount. (Employers will need to make assumptions on taxation of excess amounts given the lack of clarity provided. We would recommend employers take the conservative approach and tax employees on any excess contributions.)
  • While on a prospective basis, employers could encourage employees to consider reducing their new election amount to account for any potential rollover amount, this is not always a known calculation. Additionally, many elections for the 2021 plan year have already been made without knowledge of this potential.

Grace Period Plans: Employers, at their discretion, may amend their §125 plans to extend the period for incurring claims.

  • This applies to plan years ending in 2020 and 2021
  • The grace period may be extended for up to 12 months after the end of the plan year.
  • Applies to both health care and dependent care FSAs. However, amounts remaining may only be used for the same benefit (health FSA or dependent care FSA). 
  • Unused amounts from one plan year that remain available at the end of a 12-month grace period (i.e., at the end of the next plan year) need not be forfeited and may be made available in the next grace period.  
  • Employers may permit an extension of a grace period for any number of months and it is not required to extend the grace period for a full 12 months.
  • Existing IRS rules regarding reporting dependent care FSA elections (W-2, Box 10) direct employers to report salary reductions elected by employees without regard to amounts that may remain available during a grace period. This rule continues to apply with respect to the extended grace period allowed under this Notice. The same applies for reporting by employees on Form 2441.
  • As with all plan provisions, notification of plan changes to employees is required. (Employee education and communication of these plan nuances is not an insignificant endeavor.)
  • Amounts made available during a grace period are not included in calculations for discrimination testing. (This will require differentiated reporting of grace period balances for testing purposes.)

Post Termination Reimbursements: The notice provides a special rule regarding post-termination reimbursements from health FSAs. At their discretion, employers may allow terminated health FSA participants to spend down their balance.    

  • This applies to employees who ceased participation during the 2020 or 2021 calendar year.
  • Reasons include termination of employment, change in employment status, or a new election to revoke contributions.
  • Unused balances may be reimbursed by expenses incurred through the end of the plan year in which participation ceased, including any grace period. (FSA administration systems are set up for this type of “spend down” arrangement for dependent care accounts, but not for health FSA plans.)
  • Employers may elect to offer a shorter spend down period.
  • Employers may limit the unused amounts to the employee’s salary reductions through the date participation ceased. (Systems are not established to allow for this type of customization.)
  • The spend-down will not prevent individuals from having a loss of coverage for COBRA purposes. Therefore, COBRA notifications offering Health FSA coverage must still be sent to Qualified Beneficiaries. Employers may allow employees to be reimbursed for up to the amount contributed to the HCFSA as of the date of the Qualifying Event or the employee may elect COBRA coverage to access the entire FSA election.

Dependent Care Age Relief: Employers may extend the maximum age from 12 to 13 when reimbursing dependent care expenses.

  • This applies for participants whose enrollment period ended on or before Jan. 31, 2020. (The wording in the Notice is a little convoluted. For elections that qualify based on the timing of the election, the Notice allows children an additional year to incur claims. If a child turned 12 and aged out of the plan during 2020, expenses could be reimbursed through age 13.
  • This provision does not apply for 2021 plan years (or for any elections after the cutoff date).    
  • Allows employees to use remaining balances which were previously elected.
  • This provision does not allow for prospective elections for children who are already over age 12.
  • Balances may be used in the following plan year.
  • Employers can adopt this relief without adopting the carryover or grace period relief.
  • Administrative difficulties will potentially ensue with this provision, especially if the participant has other eligible children. (FSA administration systems are built to track dependent care reimbursements against the total balance, not to specific children.)

Mid-Year Election Changes – FSA Plans: The guidance allows certain, prospective mid-year election changes for health and dependent care FSAs for plan years ending in 2021. At the employer’s discretion, plans may allow employees to prospectively revoke, increase, decrease, or make a new FSA election mid-year.

  • Election changes are not required to meet the standard election change requirements outlined by the IRS.
  • Amounts contributed to an FSA after a revised election can be used for eligible expenses incurred during the first plan year beginning on or after January 1, 2021, even if the employee was not enrolled in the FSA on January 1, 2021.
  • Employers must define how unused contributions are treated following a revocation. Specifically, are contributions available to reimburse expenses incurred during the rest of the plan year or only before the revocation? (FSA administration systems do not typically do not allow for this type of customization.)
  • HSA eligibility will be impacted by a “crossover” in reimbursement eligibility due to this provision. If a health FSA allows an election revocation that terminates plan participation but allows reimbursements to be received regardless of when expenses were incurred, the health FSA will be considered disqualifying coverage for HSA eligibility purposes.
  • If expenses incurred before participation ends can be submitted, the health FSA will not be considered disqualifying coverage for months after the revocation date.
  • An employer may allow amounts contributed to a health FSA or dependent care FSA after a prospective election change opportunity, to be used for any eligible expenses incurred retroactively to the start of the plan year that begins on or after January 1, 2021.
  • For example, under a calendar year plan, an employee who makes a mid-year election to enroll in an FSA on February 1, 2021 may use the FSA for claims incurred back to January 1, 2021, even though the employee was not enrolled in a health FSA or dependent care FSA at that time. (FSA administration systems are typically set up to require claims to be incurred after the election date, as is required by the regular cafeteria plan rules.)
  • Allowing elections to cover retroactively incurred claims is a significant deviation from all standing guidance for FSA plans. It also opens up the plan to the potential for significant adverse selection and payroll processing complexities.

Mid-Year Election Changes – Health Plans: The guidance also presents a NEW election change opportunity for plan participants. Participants may make prospective mid-year election changes in medical, dental or vision coverage.

  • Applies to plan years ending in 2021.
  • At the employer’s discretion, plans may allow employees to prospectively make any of the following changes mid-year:
    1. Make a new health plan election
    2. Revoke and existing health coverage election and elect other coverage offered by the employer
    3. Revoke an existing health coverage election.
  • Election changes are not required to meet the standard election change requirements outlined by the IRS.
  • If coverage is revoked, employees must attest in writing that they have obtained other health coverage not sponsored by the employer. (A sample attestation is provided.)
  • Employers have full latitude to offer some or all of the election change opportunities. This includes restricting changes to a specific type of coverage (say, medical only) or offering change opportunities for certain of the change options but not others.

HSA Issues

The relief measures provided for FSA plans could wreak havoc on participants making contributions to an HSA. To this end, the IRS directly addressed and clarified several important issues.

  • Carryover relief, grace period relief, and health FSA spend-down are considered extensions of non-HDHP coverage that adversely affect eligibility for HSA contributions (unless the health FSA is HSA-compatible).
  • Plans can be amended to allow employees to opt out of a carryover or extended period for incurring claims in plan years ending in 2021 and 2022 to preserve HSA eligibility. (But this add significant complexity for employers and FSA administrators since these type of elections are not typically done on an individual basis.)
  • Plans may also allow midyear election changes to switch between HSA-compatible and general-purpose health FSAs (or vice versa).
  • Care must be taken when making any such change as both timing of coverage and type of account matter in defining HSA eligibility. To maintain HSA eligibility, it is important that participants not be covered by a general purpose FSA or any other non-HDHP coverage.

Health Plan Election Changes

Employers, at their discretion, may permit §125 plan participants to make the following changes, provided they are made on a prospective basis:

  • Make a new election (if the employee initially declined to elect employer-sponsored health coverage)
  • Revoke an existing election and make a new election to enroll in different health coverage (sponsored by the same employer)
  • Revoke an existing election, 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.

This applies to health, dental, or vision coverage, and it applies for plan years ending in 2021. This relief mirrors previously provided relief for calendar year 2020).

For the situation when an employee attests that they have or will enroll in other health coverage, sample attestation language is provided in the notice. Also, the notice states that employers may rely on an employee’s attestations absent actual knowledge to the contrary.

Employers have full discretion in electing to fully or partially extend these relief measures and can place certain other limits on these changes so long the plan impact does not discriminate among plan participants.

Plan Amendments 

Consolidated Appropriations Act of 2021: Employers wishing to implement elements of the permissible changes allowed by the Consolidated Appropriations Act of 2021 must adopt an amendment by the last day of the first calendar year beginning after the end of the plan year in which the amendment is effective. For example, for calendar year 2020 plans, amendments must be adopted prior to December 31, 2021. In the meantime, plans must operate their plans in accordance with the amendment’s terms retroactive to its effective date.

Employers must also inform eligible employees of the changes. The deadline for adopting a carryover relief amendment is based on the end of the plan year from which the funds are carried over.

CARES Act: Employers planning on implementing Cares Act provisions allowing tax-favored reimbursement of expenses for OTC drugs without prescriptions and menstrual care products in health FSAs and HRAs must also execute formal plan amendments.

Employer Action

Employers should review the permissive flexibility offered by the CAA and carefully consider whether to adopt any provisions. The additional administrative burden (both internally and in concert with FSA administrators) and the potential cost (both time and potential administrative expense) should be carefully weighed against the additional flexibility the relief offers for plan participants.

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