In response to the 2019 novel coronavirus outbreak (COVID-19), earlier this week the IRS issued two notices allowing certain changes to cafeteria plans. Notice 2020-33 increases the limit on unused amounts remaining at the end of the plan year in a health flexible spending arrangement (FSA) that may be carried over to pay or reimburse medical expenses incurred in a subsequent plan year to $550, and clarifies the timing for health plan reimbursements. Notice 2020-29 permits employers to amend their cafeteria plans to allow employees to make mid-year changes to employer-sponsored health coverage, health FSAs, and dependent care assistance programs (including dependent care FSAs) without experiencing a status change event, and extends the claims period for health FSAs and dependent care assistance programs. The Notice also clarifies and expands earlier relief allowing high deductible health plans (HDHPs) to cover expenses related to COVID-19 and telehealth services retroactive to January 1, 2020.
IRS Notice 2020-33
Increased Health FSA Carryover Limit
Notice 2020-33 modifies IRS Notice 2013-71, by increasing the carryover limit for unused health FSA carryover amounts from $500 to $550. Employees may contribute up to $2,750 (for 2020) to a health FSA for a plan year. Because a cafeteria plan may not provide for deferred compensation, amounts contributed to a health FSA are subject to a “use it or lose it” rule. Any unused amounts in a health FSA at the end of a plan year (after the grace period for submitting expenses has expired) are forfeited by the employee. The IRS has approved two options that permit employers to liberalize the use it or lose it rule. First, a cafeteria plan may permit employees to submit for reimbursement expenses incurred during a designated grace period not to exceed two months and 15 days following the end of the plan year. Second, a cafeteria plan may permit an employee to carryover unused amounts up to $500 to pay or reimburse expenses incurred in the following plan year. Amounts in excess of $500 are forfeited. The employee may still elect the full health FSA contribution permitted by law in the following plan year. An employer may elect to adopt either option, but may not adopt both options.
The $500 amount is now indexed for inflation. Under Notice 2020-33, the maximum unused amount for a plan year beginning in 2020 that may be carried over to a plan year beginning in 2021 is $550. As a general rule, an employee may not modify a benefit election for a health FSA after the first day of the 2020 plan year. However, if an employee wants to increase his or her health FSA election in light of the increased carryover limit for 2020, the employee may do so in accordance with the relief issued under IRS Notice 2020-29 described below.
Timing for Reimbursements by Health Plans
A health plan, including a premium reimbursement plan in a cafeteria plan or an individual coverage health reimbursement arrangement (HRA), may not reimburse expenses incurred before the beginning of a plan year and qualify for favorable tax treatment. Medical expenses are treated as incurred when the medical care that gives rise to the expense is provided, and not when the expenses are billed or paid. Notice 2020-33 provides that a health plan may treat an expense as incurred (1) on the first day of each month of coverage on a pro rata basis, (2) the first day of a period of coverage, or (3) the date the premium is paid. For example, an individual coverage HRA with a calendar-year plan year may immediately reimburse a (substantiated) premium for health insurance coverage that begins on January 1 of the plan year, even if the individual paid for the coverage prior to the first day of the plan year.
IRS Notice 2020-29
Notice 2020-29 provides for increased flexibility (1) with respect to mid-year benefit election changes under a cafeteria plan (a plan that complies with Internal Revenue Code Section 125) for health plan coverage and health and dependent care FSAs, and (2) for participants to apply unused amounts in health and dependent care FSAs to reimburse expenses incurred through December 31, 2020. The Notice also clarifies and extends relief for retroactive coverage of COVID-19 related medical expenses and telehealth services.
Flexibility for Mid-Year Changes
As a general rule, an election under a cafeteria plan to pay for benefits on a pre-tax basis, including health FSAs and dependent care assistance programs, must be made before the beginning of the plan year to which the election relates. Once made, the election is irrevocable, and may be changed only if the participant experiences a change in status (such as the birth of a child, a divorce, or a reduction in hours of employment), or there is a significant change in the cost or type of coverage. Due to COVID-19, employees may have unanticipated changes in their needs for medical care and dependent care. Employees may wish to enroll in or drop employer-provided health plans or increase or decrease their health FSA contributions. In addition, an employee may have an increased or decreased need for childcare due to unanticipated closings of schools and child care providers (including summer day camps) and changes to the employee’s work location or schedule. Although some of the events may qualify as a status change event (e.g., a change in dependent care provider), employees may have reasons for changing their elections that are not qualified status changes or may have missed deadlines to change their elections because they did not anticipate how long events like furloughs or daycare closings would last.
Notice 2020-29 permits employers to amend their cafeteria plans to allow employees to make mid-year election changes for employer-sponsored health coverage, health FSAs and dependent care assistance programs (including dependent care FSAs) during the 2020 calendar year, regardless of whether the employee experiences a status change event. Specifically, an employee may (1) make a new election for employer-sponsored health coverage if the employee initially declined coverage, (2) revoke an election for existing employer-sponsored health coverage and enroll in different coverage sponsored by the same employer (including changing from self-only to family coverage), (3) revoke an election for existing employer-sponsored health coverage, provided the employee attests that he or she has or will in enroll in other health coverage not sponsored by the employer, (4) revoke an election, make a new election, or decrease or increase an existing election for a health FSA (including a limited-purpose health FSA offered in connection with an HDHP), and (5) revoke an election, make a new election, or decrease or increase an existing election for a dependent care assistance program. A change in a benefit election (including a new election) must be made prospectively; no retroactive changes are permitted. The new rules permitting flexibility for mid-year changes do not apply to other benefits offered under a cafeteria plan, such as life insurance. An employee must experience a status change event to make a mid-year benefit election change for other benefits.
An employer is not required to adopt all or any of the permitted changes. Instead, the employer, in its discretion, may adopt one or more changes and may limit changes, provided it does so in a manner that does not discriminate in favor of highly compensated employees. For example, to prevent adverse selection of health coverage, an employer may limit elections to circumstances where coverage is increased (e.g., self-only to family coverage). In addition, an employer may prohibit participants from reducing their health FSA and dependent care assistance program elections below an amount for which they have already been reimbursed. For example, if an employee elected to contribute $2,000 to her health FSA account beginning January 1, 2020 and has already been reimbursed for $1,000 in medical expenses, the employer can prevent the participant from lowering her election below $1,000 to avoid an experience loss for the plan. The relief provided for benefit election changes may be applied retroactively to January 1, 2020 to cover benefit election changes that were permitted by an employer, but may not have qualified as status change events.
Extended Claims Period for Health FSAs and Dependent Care Assistance Programs
As described above, a cafeteria plan may permit employees to submit for reimbursement expenses incurred during a designated grace period not to exceed two months and 15 days following the end of the plan year. Notice 2020-29 permits an employer to amend its cafeteria plan to apply unused amounts remaining in a health FSA or a dependent care assistance program as of the end of a grace period ending in 2020 or a plan year ending in 2020 to pay or reimburse expenses incurred through December 31, 2020. For example, if a health FSA with a calendar-year plan year has a grace period ending on March 15, the employer may amend the plan to provide that unused health FSA amounts as of March 15, 2020 may be used to reimburse medical expenses incurred through December 31, 2020.
The extension of time for incurring claims also applies to cafeteria plans that provide for health FSA carryovers (despite guidance in Notice 2013-71 that provides a plan cannot permit both a grace period and a carryover provision). The Notice provides the following example. Assume that an employer maintains a cafeteria plan and health FSA that allows a $500 carryover for the 2019 plan year that begins July 1, 2019 and ends June 30, 2020. Pursuant to Notice 2020-29 and Notice 2020-33, the employer amends the plan to adopt (1) a $550 (indexed) carryover beginning with the 2020 plan year and (2) a temporary extended grace period for the 2019 plan year, allowing for claims incurred through December 31, 2020 to be paid with health FSA amounts from the 2019 plan year. Assume further that an employee has a health FSA balance of $2,000 for the 2019 plan year on June 30, 2020 (because an elective surgery was postponed), elects to contribute $2,000 to the health FSA for the plan year beginning July 1, 2020, and spends $1,900 on the surgery by December 31, 2020. The employee may be reimbursed $1,900 from the health FSA and may carry over the unused $100 to reimburse expenses incurred during the 2020 plan year. The employee may be reimbursed for $2,100 of medical expenses incurred during the period between January 1, 2021 and June 30, 2021. If the employee does not use the full $2,100, he or she may carry over up to $550 for the plan year beginning July 1, 2021. A grace period is not available for the plan year ending June 30, 2021.
The extension of the period for incurring claims that may be reimbursed by the health FSA is an extension of coverage by a health plan that is not an HDHP for purposes of determining if an employee may contribute to a Health Savings Account (HSA). Accordingly, an employee who has unused amounts in a health FSA remaining at the end of a plan year or grace period ending in 2020 and who is allowed an extended period to incur expenses under the health FSA pursuant to this Notice will not be eligible to contribute to an HSA (unless the health FSA is a limited purpose health FSA).
COVID-19-Related Expenses and Telehealth Services under High Deductible Health Plans
An HDHP may not provide benefits to covered individuals until the HDHP deductible is satisfied. The Families First Coronavirus Response Act requires health plans to cover COVID-19 testing and related provider visits at 100% with no cost-sharing. The Coronavirus Aid, Relief, and Economic Security Act (CARES Act) relaxes HDHP rules further by allowing telehealth and other remote care to be covered with no or limited cost sharing before an individual reaches the HDHP deductible. IRS Notice 2020-15 clarifies that (1) a health plan that otherwise satisfies the requirements to be an HDHP will not fail to be an HDHP merely because it covers COVID-19 testing and treatment without a deductible and (2) individuals will not be disqualified from making deductible contributions to an HSA paired with an HDHP. Notice 2020-29 extends the relief provided by Notice 2020-15 to telehealth and remote care services. An individual with coverage under an HDHP may receive coverage for telehealth and remote care services outside of the HDHP before satisfying the HDHP deductible and may still contribute to an HSA on a tax-favored basis. In addition, Notice 2020-29 clarifies that the relief applies with respect to the reimbursement of expenses incurred and telehealth services provided on or after January 1, 2020 and for plan years beginning on or before December 31, 2021. As an example, an individual who received COVID-19 testing or telehealth services in February of 2020 before satisfying the HDHP deductible will still receive favorable tax treatment for contributions to an HSA for 2020.
An employer that decides to increase the health FSA carryover limit for the 2020 plan year must adopt a plan amendment providing for the increased limit on or before December 31, 2021. The amendment may be effective retroactive to the first day of the 2020 plan year, provided the employer operates the plan in accordance with the amendment and informs all employees eligible to participate in the plan of the carryover provision. An employer that decides to allow increased flexibility with respect to mid-year election changes during calendar year 2020 or an extended claims period for health FSAs and dependent care assistance programs as described above must adopt an amendment to its cafeteria plan on or before December 31, 2021. The amendment may be effective retroactive to January 1, 2020 or a later date, provided the employer operates the plan in accordance with the amendment and informs all employees who are eligible to participate in its cafeteria plan of the changes made by the amendment. The amendment must apply only to mid-year elections made during calendar year 2020 and to an extended period to reimburse expenses incurred through December 31, 2020.