New Stimulus Law Permits Additional Cafeteria Plan Flexibility (Updated to Include Changes Made by IRS Notice 2021-15 and Announcement 2021-7)
Generally, the rules governing Section 125 cafeteria plans require that an employee’s benefit elections be irrevocable throughout each plan year, absent a change in the employee’s status (marriage, divorce, birth of a child, etc.) or significant changes in the cost of coverage during the year. In addition, the “use it or lose it” rule requires that amounts remaining in employees’ Health and Dependent Care Flexible Spending Accounts (FSAs) at the end of each plan year be forfeited by the employee, subject to a couple of limited exceptions.
The coronavirus pandemic has made it more difficult for employees to budget their families’ health care and dependent care needs, and to effectively spend down balances in FSAs. In response, guidance issued by the IRS on May 12, 2020 (Notice 2020-29) provided substantial flexibility to change cafeteria plan elections during 2020, as well as extended grace periods for spending unused amounts in both Health and Dependent Care FSAs. The federal stimulus law enacted on December 27, 2020 (the Consolidated Appropriations Act, 2021, referred to in this bulletin as the “CAA”) provided additional opportunities for flexibility in cafeteria plan administration extending into 2021 and 2022. On February 18, 2021, the IRS issued Notice 2021-15 to clarify and supplement the CAA changes. On March 26, 2021, the IRS issued Announcement 2021-7 to notify employers and individuals that amounts paid for personal protective equipment (PPE) are treated as amounts paid for medical care under Section 213(d) of the Internal Revenue Code, and can therefore be reimbursed from Health FSAs. This updated bulletin reflects all current rules as modified through Notice 2021-15 and Announcement 2021-7.
As with the 2020 IRS notice, the changes made available by the CAA, Notice 2021-15 and Announcement 2021-7 are optional; employers may elect to incorporate any or all of the available changes into their plans, or they may elect to simply continue to administer their cafeteria plans by applying traditional rules. A summary of the available changes follows. In each case, a description of the general rule, the changes permitted by the 2020 IRS notice, and the changes permitted by the CAA (as clarified and supplemented by Notice 2021-15 and Announcement 2021-7) are included.
General Rule. Employees are not permitted to change their cafeteria plan elections during a plan year, absent a change in status or the cost of coverage.
2020 IRS Notice. During the 2020 calendar year, and if permitted by the employer, employees were allowed to change their salary reduction elections with respect to (a) employer-sponsored health coverage, (b) Health FSAs, and/or (c) Dependent Care FSAs, on a prospective basis.
New CAA Rule. During plan years ending in 2021 (e.g., the 2021 calendar year for a plan that operates on the calendar year), and if permitted by the employer, employees are again allowed to change their salary reduction elections with respect to (a) employer-sponsored health coverage, (b) Health FSAs, and/or (c) Dependent Care FSAs, on a prospective basis. However, an election to drop employer-sponsored health coverage is contingent upon the employee’s attestation that the employee is getting coverage elsewhere, such as coverage provided under a plan maintained by the spouse’s employer or an ACA marketplace. (The CAA itself did not permit changes with regard to employer-sponsored health coverage, but this provision was expanded to include employer-sponsored health coverage by Notice 2021-15.)
General Rule. As an exception to the “use it or lose it” rule, the “grace period” rule permits a participant to apply unused amounts (including amounts remaining in a Dependent Care FSA as well as a Health FSA) at the end of a plan year to pay expenses incurred for those same benefits during a period of up to two months and 15 days immediately following the end of the plan year (e.g., through March 15 for a cafeteria plan operating on the calendar year).
2020 IRS Notice. A cafeteria plan could be amended to permit employees to apply unused amounts remaining in a Health FSA or a Dependent Care FSA as of the end of a grace period ending in 2020 to pay or reimburse medical care expenses or dependent care expenses, respectively, incurred through December 31, 2020. As an example, the grace period for a cafeteria plan for the 2019 calendar year expired March 15, 2020 under the normal rules. Under the 2020 IRS notice, the plan could be amended to permit employees to apply any unused amounts to expenses incurred on or before December 31, 2020.
New CAA Rule. Employers may amend their plans to expand the normal 2½ month grace period to 12 months, effective for plan years ending in 2020 or 2021. For a cafeteria plan operating on the calendar year, this means that the grace period for 2020 can be extended to December 31, 2021, and the grace period for 2021 can be extended to December 31, 2022.
General Rule. As a separate exception to the “use it or lose it” rule, the “carryover” rule allows a cafeteria plan to permit unused amounts remaining in a Health FSA at the end of a plan year to carry over to the following plan year, to pay or reimburse a participant for medical care expenses incurred during such following plan year, subject to the carryover limit (currently $550). This exception is not normally available with regard to Dependent Care FSAs. With regard to Health FSAs, a cafeteria plan may include the grace period rule, the carryover rule, or neither rule, but may not include both rules.
2020 IRS Notice. A cafeteria plan could be amended to permit employees to apply unused amounts remaining in a Health FSA or a Dependent Care FSA at the end of a grace period or plan year ending in 2020 to pay or reimburse medical care expenses or dependent care expenses, respectively, incurred through December 31, 2020. As an example, the grace period under a cafeteria plan for the 2019 calendar year expired March 15, 2020 under the normal rules. Under the 2020 IRS notice, the plan could permit employees to apply any unused amounts to expenses incurred on or before December 31, 2020. (Note: Because of the wording of the effective date provision in the 2020 IRS notice, this relief was available to plans with grace periods and plans that did not operate on the calendar year, but was not available to a calendar year plan with no grace period.)
New CAA Rule. Employers may amend their plans to allow employees to carry over all unused amounts in an FSA from a plan year ending in 2020 to a plan year ending in 2021 and from a plan year ending in 2021 to a plan year ending in 2022. For example, in the case of a cafeteria plan operating on the calendar year, a December 31, 2020 FSA balance could be spent as late as December 31, 2021, and a December 31, 2021 FSA balance could be spent as late as December 31, 2022. This rule is not subject to any dollar limit, and applies to Dependent Care FSAs as well as Health FSAs.
General Rule. Employees whose participation in the cafeteria plan ends (e.g., due to termination of employment) have been able to use amounts remaining in their Dependent Care FSAs to pay for dependent care expenses incurred later in the plan year, but this opportunity was not available with respect to Health FSAs.
2020 IRS Notice. The 2020 IRS notice did not include any changes in this area.
New CAA Rule. Employers may amend their plans to allow employees who terminate participation during either of the 2020 or 2021 calendar years to spend down unused Health FSA balances through the end of the plan year containing the date of termination (similar to what is already permitted for Dependent Care FSAs). Expenses incurred during a grace period applicable to the particular FSA for one of these years (including extensions provided under the CAA) may also be used to exhaust the FSA. (Note: Notice 2021-15 clarifies that this spend-down feature under a Health FSA does not relieve the employer of its obligation to offer COBRA continuation coverage with respect to the Health FSA. Due to this layer of complication, our expectation is that most employers will not want to add this feature to their plans.)
Dependent Care Age Limit:
General Rule. Reimbursements for child care from a Dependent Care FSA are limited to expenses incurred with respect to children who are under age 13.
2020 IRS Notice. The 2020 IRS notice did not include any changes in this area.
New CAA Rule. Employers may amend their plans to temporarily increase the age limit for qualified dependent care expenses. More specifically, a participant in a Dependent Care FSA can continue to receive reimbursements for a child’s dependent care expenses for the remainder of a plan year after the child’s 13th birthday (provided that the enrollment period for the plan year ended on or before January 31, 2020) and, if there were unused amounts in that plan year, continue to use any balance remaining during the following plan year until the child’s 14th birthday. This rule is only available to a participant who (a) was enrolled in the Dependent Care FSA for the last plan year with respect to which the regular enrollment period ended on or before January 31, 2020 (e.g., the 2020 plan year for a calendar year plan), and (b) has a child who attains age 13 in that plan year (and if there were unused elected amounts in that plan year, in the next plan year).
General Rule. Employees who participate in Health Savings Accounts (HSAs) are not eligible to participate in forms of medical coverage (including FSAs) other than high-deductible health plans. An exception is available for a “limited-purpose FSA,” e.g., one limited to dental and/or vision expenses.
2020 IRS Notice. The 2020 IRS notice did not include any changes in this area.
New CAA Rule. Although the CAA itself did not address this issue, Notice 2021-15 offers a number of options to help preserve HSA eligibility for employees who would otherwise lose that eligibility due to a carryover period or extended grace period adopted by their employer. These options include automatically treating a leftover amount as available only under a limited-purpose FSA, permitting the employee to waive any leftover balance, or limiting the carryover or grace period window to less than 12 months (thereby allowing the employee to have a full HSA contribution under the rule allowing such contribution if eligible for HSA participation on December 1).
Health FSA Eligible Expenses:
General Rule. Generally, the expenses eligible for reimbursement from a Health FSA are expenses paid for medical care as described in Section 213(d) of the Internal Revenue Code. Lists of specific Health FSA reimbursable expenses are typically available under cafeteria plan terms.
2020 IRS Notice, CAA, and CARES Act. None of the 2020 IRS notice, the CAA and Notice 2021-15 included any changes in this area. An earlier law (the CARES Act enacted in March 2020), however, expanded the list of Health FSA reimbursable expenses to include over-the-counter medications and menstrual care products, effective with respect to items purchased after December 31, 2019.
Announcement 2021-7. Announcement 2021-7 notified employers and individuals that amounts paid for personal protective equipment (PPE), such as masks, hand sanitizer and sanitizing wipes, for the primary purposes of preventing the spread of COVID-19, are treated as amounts paid for medical care under Section 213(d), and are therefore eligible for reimbursement from Health FSAs. Depending on the language in the cafeteria plan, the plan may need to be amended to include this change (if desired by the employer). The amendment can be made effective with respect to PPE expenses incurred during any period beginning on or after January 1, 2020. As a practical matter, however, employers may want to consider a more current effective date (e.g., January 1, 2021), as employees may not have kept receipts with respect to PPE purchased last year.
Plan Amendments and Employee Communications:
As stated above, all of the changes described above are optional; an employer is permitted, but not required, to make these changes to its particular cafeteria plan. An employer is also permitted to adopt some, but not all, of the available changes. Many employers will want to provide maximum flexibility to their employees. However, increased flexibility for employees could result in increased costs for employers (as lesser forfeitures will be available to offset those costs) as well as complications in plan administration. The accompanying 2021 Cafeteria Plan Amendment Checklist can be used by an employer to indicate the changes the employer wishes to include in its plan amendment.
If an employer is inclined to permit a 12-month grace period or a 12-month carryover, which one should it choose? As both options provide for the same result (allowing employees to spend unused FSA balances on expenses incurred during the following plan year), both options are not needed concurrently. The practical answer is that it does not make a difference. As an exception, however, an employer that wants to allow terminated Health FSA participants to spend down balances by incurring post-termination claims should choose the extended grace period, as this option is only available to Health FSAs with grace periods, and not to those with carryovers. Barring the applicability of that exception, the option most similar to prior plan provisions (the option with which employees are already familiar) is probably the best choice. For example, a plan that has traditionally provided for the regular 2½ month grace period should simply be amended to extend that period to 12 months, as opposed to adding a new carryover provision.
The CAA (as clarified via Notice 2021-15) permits employers to implement desired changes in operation and then amend their cafeteria plans as late as December 31, 2021 to reflect those changes. Announcement 2021-7 allows employers to amend their plans to include PPE as Health FSA reimbursable expenses as late as the last day of the first calendar year beginning after the end of the plan year in which the amendment is effective, subject to a deadline of December 31, 2022 for any amendment with retroactive effect. However, all of these changes are of course helpful to employees only if they are made aware of their availability. Therefore, adoption of plan amendments and distribution of employee communications (e.g., updated Summary Plan Descriptions and/or employee notices) are suggested as soon as possible.
Please contact Gary Gunnett at (412) 288-2210 or firstname.lastname@example.org with any questions on any of the above.
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Jessica A. Ellel
Chair of Houston Harbaugh’s Health Law Practice, Jessica works almost exclusively with health care entities and health practitioners. She has extensive experience with:
- Drafting and negotiating physician employment agreements from both the physician and employer perspectives
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- Advising on corporate governance issues, from practice formation to dissolution
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Jessica is especially well-versed in HIPAA compliance and authors numerous client updates and bulletins on the subject. She conducts on-site and remote HIPAA training and also maintains Houston Harbaugh’s HIPAA compliance manual, ” Federal HIPAA Privacy Standards Simplified: A Comprehensive Tool-Kit”.