On May 12, 2020, the IRS issued new guidelines in Notice 2020-29 and Notice 2020-33 that give greater flexibility to employers that provide benefits through §125 cafeteria plans, including employer-sponsored health coverage, health Flexible Spending Accounts (FSAs), and Dependent Care Assistance Programs (DCAPs). These guidelines are a welcome reprieve to plan participants that were blindsided by COVID‑19 and, as a result, had their healthcare plans and savings thrown into disarray.
New 2020 Mid-Year Election Options
Section 125 of the Internal Revenue Code allows employers to offer cafeteria plans to their employees so that employees may contribute to their health care coverage, or to FSAs or DCAPs, on a pre-tax basis. Generally, once an election is made, it cannot be changed during the course of a plan year, barring certain significant life events. For example, an employee who experienced unanticipated medical costs couldn’t elect to increase their FSA contributions in the middle of the plan year (and thus use more pre-tax dollars to pay for those unexpected costs).
Under the new guidelines, an employer now can amend their cafeteria plans and allow employees to make mid-year election changes in 2020 so long as: (i) the employee’s individual election is prospective in nature; (ii) the employer formally adopts the plan amendment by December 31, 2021 (although the proposed plan changes can go into immediate effect and be made retroactive to January 1, 2020), and; (iii) the amendment does not cause the plan to violate the Code’s nondiscrimination requirements. Mid-year elections that employers may now allow for employees include:
- A new election for employer-sponsored health coverage, if the employee originally declined to elect the health coverage.
- A change to an existing election for employer-sponsored health coverage, including changing enrollment from self-only coverage to family coverage.
- A revocation of an existing election for employer-sponsored health coverage, provided that the employee attests in writing that they are enrolled, or immediately will enroll, in health coverage not sponsored by their employer.
- A new election, a revocation of an election, or an increase or decrease to an existing election regarding an FSA or DCAP.
Employers are NOT required to make any of these cafeteria plan amendments, and may pick and choose as they like. For example, employers can decide to amend their plans so that only coverage improvements may be elected mid-year, such as going from self-only to family coverage.
Extended Claims Periods for FSAs and DCAPs in 2020, and Increased Carryovers for FSAs
Because COVID-19 caused healthcare providers to suspend elective procedures, and daycare providers to shutter their doors, many employees who contributed to FSAs and DCAPs had significant surpluses at the end of their plan year. Typically, plan participants are subject to some form of “use it, or lose it” rule, meaning that these significant surpluses would have been lost in the chaos of COVID-19.
Under the new guidelines, employers may amend their cafeteria plans to extend the grace period through the end of 2020 for employees to use these FSA and DCAP surpluses. Likewise, for a plan year beginning in 2020, employers may permit employees to carryover a maximum $550 (as opposed to only $500) into 2021, with the $550 maximum indexed in future years for inflation. These potential amendments could save employees thousands of dollars in healthcare expenses.
Example: Ann has an FSA under an employer-sponsored cafeteria plan. The 2019 plan year is from July 1, 2019 to June 30, 2020, and the 2019 plan allows a carryover of only $500. Ann had intended to get a knee replacement in May 2020, but it was postponed due to COVID-19. As of June 30, 2020, Ann has $2,000 in her FSA.
Ann elects to contribute $2,000 to her FSA for the 2020 plan, which runs from July 1, 2020 to June 30, 2021. Ann is able to reschedule her knee surgery, and, between July 1, 2020 and December 31, 2020, she incurs $1,900 in medical expenses. The FSA may reimburse Ann the full $1,900 from the 2019 plan year, leaving a $100 surplus. Under the plan terms that allow for a carryover, Ann may use this $100 surplus for medical expenses through June 30, 2021. In total, Ann may be reimbursed $2,100 (i.e. the $2,000 contributed to the 2020 plan year, plus the $100 surplus from the 2019 plan year) for medical expenses incurred between January 1, 2021 and June 30, 2021. Finally, Ann may carryover to the 2021 plan year, which is from July 1, 2021 to June 30, 2022, up to $550 from any remaining portion of that $2,100.
Implementing These New Guidelines
It is important for employers to remember that none of the cafeteria plan amendments listed in the new IRS guidelines are mandatory. However, they can be of enormous benefit to you and your employees, saving them thousands of pre-tax dollars and providing access to healthcare coverage during an uncertain time. If you have questions about how, or if, you may wish to amend your cafeteria plans, please contact Demetrius Robinson (email@example.com or 614.427.5749) or Melissa Yasinow (firstname.lastname@example.org or 216.736.7205), or any of our Tax professionals.