IRS Relaxes Cafeteria Plan Rules for COVID-19 and Increases Health FSA Carryover to $550

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By: Brian Gilmore, Lead Benefits Counsel, VP

Coming shortly on the heels of major HIPAA, COBRA, and ERISA timeframe relief, today the IRS issued two landmark pieces of Section 125 cafeteria plan guidance:

IRS Relaxes Mid-Year Section 125 Cafeteria Plan Election Change Rules for COVID-19

Standard Rule: The Irrevocable Election Rule

The general rule under Section 125 is that employee health and welfare plan and FSA elections (including an affirmative or default election not to participate) to pay the employee contribution on a pre-tax basis through the cafeteria plan must be:

  1. Made prior to the start of the plan year; and
  2. Irrevocable for the plan year unless the employee experiences a permitted election change event.

Insurance carriers (and stop-loss providers for self-insured plans) generally follow the same Section 125 permitted election change event rules with respect to mid-year coverage change elections.

For full details, see our ABD Office Hours Webinar: Section 125 Cafeteria Plans.

For a summary of the permitted election change events, see our ABD 2020 Section 125 Permitted Election Change Event Chart.

Five New Permitted Mid-Year Election Changes

In response to the COVID-19 pandemic, the IRS has relaxed the irrevocable election rule and strict list of permitted election change events to allow employees to make five additional prospective mid-year election changes under the Section 125 cafeteria plan during calendar year 2020. 

Employers may amend their Section 125 cafeteria plans on or before December 31, 2021 to adopt these new IRS relaxed mid-year election change rules retroactively to January 1, 2020.  Employers must operate the cafeteria plan in accordance with these new rules and inform all employees eligible to participate of the changes to the plan prior to adopting the plan amendment.

  1. Mid-Year Health Plan Enrollment for Waived Employees

Employers may amend their Section 125 cafeteria plan to allow employees who originally waived health plan coverage to make a new election in calendar year 2020 for employer-sponsored health coverage on a prospective basis.

Keep in mind that this relaxed mid-year election change approach addresses only the ability of employees to pay the employee-share of the premium for such health coverage on a pre-tax basis.  There is no requirement that the insurance carriers (or stop-loss providers for self-insured plans) permit employees to enroll mid-year without experiencing a permitted election change event. 

Employers must therefore first ensure that the insurance carrier (or stop-loss provider for self-insured plans) will accept employees’ mid-year enrollment without experiencing a permitted election change event for this new election opportunity to be made available.

Example 1:

  • Employee waived health plan coverage at open enrollment for 2020 coverage.
  • Employer confirms with the insurance carriers and/or stop-loss providers that its plan can accept mid-year enrollment without employees experiencing a permitted election change event (e.g., through a special enrollment period designated by the carrier).
  • Employer will amend its Section 125 cafeteria plan by December 31, 2021 to permit these new IRS relaxed mid-year election change rules.
  • Employer informs all eligible employees of the mid-year enrollment opportunity.

Result 1:

  • Within the parameters established by the insurance carriers and/or stop-loss providers, the employee can in calendar year 2020 revoke the election to waive coverage and change his election to enroll in the health plan on a prospective basis for the remainder of the 2020 plan year.
  • Employee can pay the employee-share of the premium for the health coverage on a pre-tax basis through the Section 125 cafeteria plan because of these new IRS relaxed mid-year election change rules.
  • Mid-Year Plan Option Change or to Add Dependents

Employers may amend their Section 125 cafeteria plan to allow employees to change their health plan election in calendar year 2020 to enroll in a different plan option or enroll dependents on a prospective basis.

Keep in mind that this relaxed mid-year election change approach addresses only the ability of employees to pay the employee-share of the premium for such health coverage on a pre-tax basis.  There is no requirement that the insurance carriers (or stop-loss providers for self-insured plans) permit employees to change plan options or enroll dependents mid-year without experiencing a permitted election change event. 

Employers must therefore first ensure that the insurance carrier (or stop-loss provider for self-insured plans) will accept employees’ mid-year plan option change or additional dependent enrollment without experiencing a permitted election change event for this new election opportunity to be made available.

Example 2:

  • Employee enrolled in employee-only coverage under the PPO at open enrollment for 2020 coverage.
  • Employer confirms with the insurance carriers and/or stop-loss providers that its plan can accept mid-year plan option changes and dependent enrollment without employees experiencing a permitted election change event (e.g., through a special enrollment period designated by the carrier).
  • Employer will amend its Section 125 cafeteria plan by December 31, 2021 to permit these new IRS relaxed mid-year election change rules.
  • Employer informs all eligible employees of the mid-year enrollment opportunity.

Result 2:

  • Within the parameters established by the insurance carriers and/or stop-loss providers, the employee can in calendar year 2020 revoke the employee-only PPO election and change his election to enroll in family HMO coverage under the health plan on a prospective basis for the remainder of the 2020 plan year.
  • Employee can pay the employee-share of the premium for the health coverage on a pre-tax basis through the Section 125 cafeteria because of these new IRS relaxed mid-year election change rules.
  • Mid-Year Dropping of Health Plan Coverage

Employers may amend their Section 125 cafeteria plan to allow employees in calendar year 2020 to revoke their health plan election on a prospective basis, provided the employee attests in writing that the employee is enrolled (or will immediately enroll) in other health coverage not sponsored by the employer.

The IRS provides the following template language employers can use for the employee’s written attestation:

Name: _______________________ (and other identifying information requested by the employer for administrative purposes).

I attest that I am enrolled in, or immediately will enroll in, one of the following types of coverage: (1) employer-sponsored health coverage through the employer of my spouse or parent; (2) individual health insurance coverage enrolled in through the Health Insurance Marketplace (also known as the Health Insurance Exchange); (3) Medicaid; (4) Medicare; (5) TRICARE; (6) Civilian Health and Medical Program of the Department of Veterans Affairs (CHAMPVA); or (7) other coverage that provides comprehensive health benefits (for example, health insurance purchased directly from an insurance company or health insurance provided through a student health plan).

Signature: ______________________

Employers may rely on this written attestation provided by the employee unless the employer has actual knowledge that the employee is not (or will not be) enrolled in other comprehensive health coverage not sponsored by the employer.

Example 3:

  • Employee enrolled in the PPO plan at open enrollment for 2020 coverage.
  • Employer will amend its Section 125 cafeteria plan by December 31, 2021 to permit these new IRS relaxed mid-year election change rules.
  • Employer informs all eligible employees of the mid-year waiver opportunity.

Result 3:

  • In calendar year 2020, the employee can revoke the PPO plan election on a prospective basis.
  • Employee can stop paying the employee-share of the premium for the health coverage on a pre-tax basis through the Section 125 cafeteria because of these new IRS relaxed mid-year election change rules.
  • Health FSA Election Changes

Employers may amend their Section 125 cafeteria plan to allow employees in calendar year 2020 to revoke, decrease, make, or increase a health FSA election on a prospective basis.

In other words, the new IRS relaxed mid-year election change rules permit employees to change their health FSA election in any manner and for any reason in calendar year 2020 on a prospective basis.

The Notice confirms this new option applies both to general purpose and limited-purpose health FSAs.  It also confirms that employers can choose to limit a mid-year health FSA election revocation or decrease to amounts no less than amounts already reimbursed to the employee by the health FSA in the plan year (to avoid potential experience losses from overspent accounts).

Employers should work closely with their health FSA TPA to ensure smooth communication and implementation of this new election change opportunity.

Example 4:

  • Employee elected to contribute $2,750 to the health FSA at open enrollment for the 2020 plan year.
  • Because of the inability to access elective surgery and other medical services during the COVID-19 pandemic, employee now anticipates his health expenses to be only $1,500 for the plan year.
  • Employer will amend its Section 125 cafeteria plan by December 31, 2021 to permit these new IRS relaxed mid-year election change rules.
  • Employer coordinates with the health FSA TPA to inform all eligible employees of the mid-year health FSA election change opportunity.

Result 4:

  • In calendar year 2020, the employee can decrease his health FSA election to $1,500.
  • Employee is no longer required to contribute $2,750 because of these new IRS relaxed mid-year election change rules.
  • Dependent Care FSA Election Changes

Employers may amend their Section 125 cafeteria plan to allow employees in calendar year 2020 to revoke, decrease, make, or increase a dependent care FSA election on a prospective basis.

In other words, the new IRS relaxed mid-year election change rules permit employees to change their dependent care FSA election in any manner and for any reason in calendar year 2020 on a prospective basis. 

Although the existing Section 125 permitted election change event rules provide employees with the ability to change their dependent care FSA election upon virtually any change in their daycare situation, these new IRS relaxed mid-year election change rules provide added flexibility.

The Notice confirms that employers can choose to limit a mid-year dependent care FSA election revocation or decrease to amounts no less than amounts already reimbursed to the employee by the dependent care FSA in the plan year.

Employers should work closely with their dependent care FSA TPA to ensure smooth communication and implementation of this new election change opportunity.

Example 5:

  • Employee elected to contribute $5,000 to the dependent FSA at open enrollment for the 2020 plan year.
  • Because of the inability to access daycare, pre-school, after-school, or other eligible dependent care services during the COVID-19 pandemic, employee now anticipates his dependent care expenses to be only $3,500 for the plan year.
  • Employer will amend its Section 125 cafeteria plan by December 31, 2021 to permit these new IRS relaxed mid-year election change rules.
  • Employer coordinates with the dependent care FSA TPA to inform all eligible employees of the mid-year dependent care FSA election change opportunity.

Result 5:

  • In calendar year 2020, the employee can decrease his dependent care FSA election to $3,500.
  • Employee is no longer required to contribute $5,000 because of these new IRS relaxed mid-year election change rules.

Extended Period to Incur Health FSA and Dependent Care FSA Claims in 2020

In response to the COVID-19 pandemic, the IRS has also relaxed the Section 125 use-it-or-lose-it rule for FSAs.  Employers may amend their Section 125 cafeteria plan to permit employees to incur reimbursable claims through the end of calendar year 2020 for any FSA plan year or grace period that ends in 2020.

The Notice confirms this new option applies both to general purpose and limited-purpose health FSAs, as well as to dependent care FSAs.

Note that a calendar plan year health FSA with the carryover provision will not benefit from this extended period because its plan year ends December 31, 2020.

Employers should work closely with their dependent care FSA TPA to ensure smooth communication and implementation of this new extended period to incur reimbursable claims through December 31, 2020.

Example 6 (Health FSA and Dependent Care FSA Grace Period, Calendar Plan Year):

  • Employer sponsors a calendar plan year health FSA and dependent care FSA, both with the grace periods ending March 15.
  • Many employees did not incur sufficient claims for the 2019 plan year by the end of the grace period ending March 15, 2020 to cover their full election.
  • Employer will amend its Section 125 cafeteria plan by December 31, 2021 to permit this new IRS extended period to incur FSA claims through the end of calendar year 2020.
  • Employer coordinates with the FSA TPA to inform all eligible employees of the extended period to incur claims through the end of calendar year 2020.

Result 6:

  • Employees with amounts remaining in their 2019 plan year health FSA can incur reimbursable health expenses through December 31, 2020 (not the standard March 15, 2020 grace period deadline).
  • Employees with amounts remaining in their 2019 plan year dependent care FSA can incur reimbursable dependent care expenses through December 31, 2020 (not the standard March 15, 2020 grace period deadline).

Example 7 (Health FSA Carryover, July 1 Plan Year):

  • Employer sponsors a July 1 – June 30 plan year health FSA with the $500 carryover.
  • Many employees have more than $500 remaining in their health FSA at the end of the plan year ending June 30, 2020 because they had to delay elective surgeries during the COVID-19 pandemic.
  • Employer will amend its Section 125 cafeteria plan by December 31, 2021 to permit this new IRS extended period to incur FSA claims through the end of calendar year 2020.
  • Employer coordinates with the FSA TPA to inform all eligible employees of the extended period to incur claims through the end of calendar year 2020.

Result 7:

  • Employees with amounts in excess of $500 remaining in their 2019 plan year health FSA ending June 30, 2020 can incur reimbursable health expenses up to the full amount of their remaining account balance through December 31, 2020 (not the standard $500 cap).

IRS Increases Health FSA Carryover Limit to $550 (Indexed)

Standard Rule: Health FSA $500 Carryover Established 2013

Since 2013, the IRS has permitted health FSAs to offer a $500 carryover provision.  The carryover is an optional plan feature available for the health FSA only (it is not available for the dependent care FSA) and that can be offered only if the health FSA does not offer the grace period.  In other words, employers must choose between the carryover or the grace period for the health FSA—with most choosing the carryover as providing a better plan feature on net.

Note that because the carryover is available only for the health FSA, many employers still offer the grace period for the dependent care FSA.  Cafeteria plans are permitted to (and often do) offer the carryover for the health FSA, and the grace period for the dependent care FSA.

IRS Indexes Carryover Limit to $550 (20% of Health FSA Salary Reduction Limit)

On June 24, 2019, President Trump issued Executive Order 13877 directing the IRS to increase the $500 carryover limit.

Today’s new IRS guidance implements that directive by increasing the maximum $500 carryover amount for 2020 or later years to an amount equal to 20% of the maximum health FSA salary reduction contribution for that plan year.  The indexed limit will be in multiples of $10.

For plan years beginning on or after January 1, 2020, the health FSA salary reduction contribution limit is $2,750.  Accordingly, the health FSA maximum carryover from a plan year starting in calendar year 2020 to a new plan year starting in calendar year 2021 is $550.

Employers wishing to offer this indexed increase the health FSA carryover limit must adopt a plan amendment to the Section 125 cafeteria plan on or before the last day of the plan year from which amounts may be carried over.  The amendment can apply retroactively to the first day of that plan year, provided the plan operates in accordance with the IRS guidance and the employer informs all employees eligible to participate in the plan of the carryover provision.

Accordingly, employers sponsoring a calendar plan year health FSA with the carryover will need to adopt an amendment incorporating the indexed carryover limit no later than December 31, 2020.

Employers should work closely with their health FSA TPA to ensure smooth communication and implementation of this newly increased carryover limit.

Employer Action Items Related to New IRS Guidance

  • Consider whether to offer new mid-year election change opportunities during calendar year 2020:
    • Coordinate with all applicable insurance carriers, stop-loss providers, and FSA TPAs;
    • Inform employees of ability to make election changes; and
    • Amend the cafeteria plan no later than December 31, 2021
  • Consider whether to offer extended period to incur FSA claims in calendar year 2020:
    • Coordinate with the FSA TPA;
    • Inform employees of ability to incur claims through December 31, 2020 where applicable; and
    • Amend the cafeteria plan no later than December 31, 2021.
  • Consider whether to offer increased $550 health FSA carryover for 2020 and beyond:
    • Coordinate with the FSA TPA;
    • Inform employees of the increased carryover limit; and
    • Amend the cafeteria plan no later than the last day of the plan year from which amounts may be carried over (by December 31, 2020 for a calendar plan year).

For a running summary of all the issues related to COVID-19 and employee benefits, see our ABD COVID-19 and Employee Benefits Guide.

Disclaimer: The intent of this analysis is to provide the recipient with general information regarding the status of, and/or potential concerns related to, the recipient’s current employee benefits issues. This analysis does not necessarily fully address the recipient’s specific issue, and it should not be construed as, nor is it intended to provide, legal advice. Furthermore, this message does not establish an attorney-client relationship.  Questions regarding specific issues should be addressed to the person(s) who provide legal advice to the recipient regarding employee benefits issues (e.g., the recipient’s general counsel or an attorney hired by the recipient who specializes in employee benefits law).

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