Executive Summary

• Covid Bill Passed: Late last night Congress passed—and President Trump is expected to sign into law shortly—a massive bill titled the Consolidated Appropriations Act, 2021 that includes stocking stuffers in the form of significant health and dependent care FSA relief. The bill passed easily by a 359-53 margin in the House and 92-6 in the Senate.

• **Full FSA Carryovers from 2020-2021 and 2021-2022 Plan Years: **For both the health FSA and the dependent care FSA, the plan may permit carryovers of the full unused balance from plan years ending in 2020 and 2021 into the subsequent plan years ending in 2021 and 2022, respectively.

• **Extended Grace Periods for 2020 and 2021 Plan Years: **For both the health FSA and the dependent care FSA, the plan may have a 12-month grace period after the plan years ending in 2020 or 2021.

• Health FSA Spend Down: Similar to the spend down option available under the dependent care FSA, the health FSA may permit employees who terminate participation mid-year during calendar year 2020 or 2021 to continue to incur reimbursable claims for the remainder of the plan year in which participation ceased.

• Dependent Care FSA Relief for Children Who Reached Age 13: Employees whose children reached age 13 during the last dependent care FSA plan year for which the enrollment period was on or before January 31, 2020 may continue to treat the child as eligible up to age 14 for such plan year.

• FSA Election Change Relief: Building on the prior IRS election change relief for 2020, the bill provides that the cafeteria plan may permit employees to change their health FSA or dependent care FSA election during plan years ending in 2021 without experiencing a permitted election change event.

• Plan Amendments May be Retroactive: Employers wishing to offer any of these optional FSA relief provisions must amend the Section 125 cafeteria plan to incorporate the changes. The amendment may be retroactive as along as it is adopted 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 plan is operated consistent with the terms of the amendment during the full retroactive period.

Why It Matters: The Section 125 Irrevocable Election and Use-It-Or-Lose-It Rules

The health and dependent care FSA are components of the Section 125 cafeteria plan.  Internal Revenue Code §125 (and its implementing regulations) imposes strict limitations on the administration of cafeteria plans.

The most fundamental of these limitations are that all FSA elections are irrevocable absent a permitted election change event, and all FSA contributions are subject to the use-it-or-lose-it rule.  After the end of the plan year and any grace period and/or run-out period, any remaining unreimbursed funds not subject to a $550 health FSA carryover must be forfeited to the plan.

For more details:

• Missing the Dependent Care FSA Run-Out Period

• The $550 Carryover vs. the Grace Period

• Health FSA Upon Termination of Employment

• Newfront Section 125 Permitted Election Change Event Chart

The Covid Problem: Qualifying Expenses Dry Up

The IRS provided welcome relief in early May that significantly relaxed the requirement that all Section 125 elections be irrevocable for the duration of the plan year absent the employee experiencing a permitted election change event.

For more details:

• IRS Relaxes Cafeteria Plan Rules for COVID-19

However, that prior guidance did not provide significant relief for amounts already contributed to the FSA.  The guidance primarily made it possible for employers to offer employees the ability to change their health FSA or dependent care FSA contribution elections on a prospective basis without experiencing a permitted election change event.

Many employees had their anticipated dependent care expenses reduced or eliminated entirely in the face of the pandemic.  Day care, pre-school, after-school, and summer camp expenses became much sparser during the shutdown and closures.

Many employees also had anticipated health care expenses that were not incurred because of the pandemic.  For example, many elective surgeries, dental costs, and other procedures have been delayed indefinitely.

Absent further legislative or IRS action, many employees would therefore have forfeited contributions to their dependent care FSA or health FSA at the end of the 2020-2021 plan years and their associated grace period and/or run-out period.

Fortunately, the Consolidated Appropriations Act, 2021 fully addresses these concerns by providing sweeping FSA relief for 2020 and 2021 that is likely to satisfy most employers and employees.

COVID Bill Permits Full Carryover of 2020 and 2021 Dependent Care FSA and Health FSA Balance into 2021 and 2022

For plan years ending in 2020 and 2021, the cafeteria plan may permit participants to carry over the full health FSA or dependent care FSA balance into the following plan year—the plan years ending in 2021 and 2022, respectively.

This is an exception from the general rule that prohibits dependent care FSA carryovers and permits carryovers of up to $550 for the health FSA.

• For more details: The 50 Carryover vs. the Grace Period

Note that employers may design the health FSA carryover provision to provide that employees enrolling in an HDHP plan option for the subsequent plan year will automatically have their carryover balance converted to limited purpose to preserve HSA eligibility.

• For more details: Health FSA Carryover and Grace Period Affect HSA Eligibility

This full carryover provision is optional.  Employers wishing to incorporate the full carryover should work closely with their FSA TPA to ensure consistency with their administrative capabilities, offerings, and communications.

COVID Bill Permits 12-Month Grace Periods Following 2020 and 2021 Plan Years

For plan years ending in 2020 and 2021, the cafeteria plan may permit the health FSA and dependent care FSA to have a 12-month grace period after the end of such plan years.

This is an exception from the general rule that permits the health FSA and dependent care FSA only to offer a 2½-month grace period.  The bill does not provide an exception from the rule that an FSA offering the carryover cannot also offer the grace period.

• For more details: The $550 Carryover vs. the Grace Period

Note that employees generally must spend down the full health FSA balance to zero by the last day of the plan year to avoid the grace period blocking HSA eligibility.  This will be a particularly important employee communications priority for employers adopting the extended grace period because of the potential for employees to lose HSA eligibility for the entire subsequent plan year.

• For more details: Health FSA Carryover and Grace Period Affect HSA Eligibility

This 12-month grace period provision is optional.  Employers wishing to incorporate the extended grace period should work closely with their FSA TPA to ensure consistency with their administrative capabilities, offerings, and communications.

COVID Bill Permits Health FSA Spend Down Provision in 2020 and 2021

For employees who terminate health FSA participation during calendar year 2020 or 2021, the cafeteria plan may provide for a spend down provision allowing terminated participants to continue incurring reimbursable claims through the end of the plan year in which participation ended (including any standard or extended grace period).

This is an exception from the general rule that permits only the dependent care FSA to offer a spend down feature in the same fashion.

• For more details: Dependent Care FSA Spend Down Provision

Note that absent IRS guidance to the contrary, this health FSA spend down provision would block terminated participants’ HSA eligibility for the remainder of the plan year.

• For more details: HSA Interaction with Health FSA

This health FSA spend down provision is optional.  Employers wishing to incorporate the spend down should work closely with their FSA TPA to ensure consistency with their administrative capabilities, offerings, and communications.

COVID Bill Permits Dependent Care FSA Eligible Child Status to Age 14

For employees who enrolled in a dependent care FSA in the last plan year for which the end of the open enrollment period ended on or before January 31, 2020 (e.g., a 2020 calendar plan year), the cafeteria plan may provide that the eligible child age limit is increased from age 13 to age 14.  To qualify, the child must have reached age 13 during such plan year (or in the subsequent plan year if the employee has an unused dependent care FSA balance available during such year).

This is an exception from the general rule that an employee’s child ceases to be a qualifying individual under the dependent care FSA upon the child’s 13 birthday.

• For more details: Dependent Care FSA When a Child Reaches Age 13

This dependent care FSA age 14 provision is optional.  Employers wishing to incorporate the age 14 extension should work closely with their FSA TPA to ensure consistency with their administrative capabilities, offerings, and communications.

COVID Bill Permits 2021 Health FSA and Dependent Care FSA Election Change Relief

For plan years ending in 2021, the cafeteria plan may permit participants to prospectively change their health FSA and/or dependent care FSA elections without experiencing a permitted election change event.  That includes any mid-year election to enroll in, increase, decrease, or revoke health FSA or dependent care FSA participation.

This is an exception from the general rule that provides Section 125 cafeteria plan elections are irrevocable for the duration of the plan year absent a permitted election change event.  The provision essentially extends similar IRS guidance broadly relaxing cafeteria plan election change rules in calendar year 2020—but in this case it is limited exclusively to FSA election changes, and it applies only for plan years ending in 2021.

• For more details: IRS Relaxes Cafeteria Plan Election Change Rules for Covid

This relaxed health FSA and dependent care FSA election change provision is optional.  Employers wishing to incorporate the relaxed FSA election change rules should work closely with their FSA TPA to ensure consistency with their administrative capabilities, offerings, and communications.

COVID Bill Permits Retroactive Cafeteria Plan Amendments

Employers adopting any of the optional provisions addressed above will need to amend their Section 125 cafeteria plan to reflect the changes.  Such amendments can be made retroactively, provided:

• The amendment is adopted not 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 plan is operated consistent with the terms of such amendment for the full retroactive period—the period beginning on the effective date of the amendment and ending on the date the amendment is adopted.

This is an exception from the general rule that a Section 125 cafeteria plan amendment must be adopted prospectively to be effective.

• For more details: Section 125 Cafeteria Plan Document Effective Date

Employers should work with their FSA TPAs to adopt amendments consistent with the employer’s desired approach and the administrative options made available by the TPA.