December 30, 2020
Benefits Law Alert
The recently signed Consolidated Appropriations Act is intended to provide various forms of tax relief, including among other things, temporary relaxation of the tax rules for health and dependent care flexible spending arrangements (“FSAs”). In this alert, we discuss the temporary relief for FSAs and highlight important takeaways for plan sponsors.
The massive Consolidated Appropriations Act, 2021, signed into law by the president on December 27, 2020, includes the Taxpayer Certainty and Disaster Relief Act of 2020 (the “Act”). The Act is intended to provide various forms of tax relief, including, among other things, temporary relaxation of the tax rules for health and dependent care flexible spending arrangements (“FSAs”). This benefits alert summarizes the temporary relief for FSAs and highlights important takeaways for plan sponsors.
As background, a primary feature of health and dependent care FSAs is the “use it or lose it” requirement. Under this requirement, unused funds in an FSA account at the end of the year are forfeited. Existing rules allow for a carryover of unused health FSA funds to the next plan year or a grace period in which unused funds can be used for claims incurred in the next plan year. Both of those exceptions to the use-it-or-lose-it requirement are limited: The health FSA carryover is capped at $550 (for 2020 and indexed thereafter) and the grace period cannot be longer than two and a half months. Further, health FSAs can allow a carryover feature or grace period, but not both.
Many FSA participants who elected to contribute to health and/or dependent care FSAs during open enrollment for the 2020 plan year may have done so in anticipation of upcoming elective healthcare procedures or in the expectation that their dependents would be in daycare or summer camp. Those expectations were probably frustrated by the COVID-19 pandemic, and therefore, many FSA accounts may have been over-funded by participants in 2020. To soften the blow of the use-it-or-lose-it requirement, the Internal Revenue Service (IRS) issued relief in May 2020 that allowed plan sponsors to extend the grace period to December 31, 2020, for the spend-down of unused 2019 contributions. It also allowed FSAs with carryover features to add the extended grace period for 2020. Given that the COVID-19 pandemic did not materially affect the United States until early spring 2020, the IRS relief described above was of limited usefulness.
The Act’s temporary relaxation of FSA rules goes much farther than the IRS relief. Details are as follows.
In general, employees must make elections to contribute to health and/or dependent care FSAs before the start of the plan year. Those elections are irrevocable, subject to permitted mid-year election change events, such as changes in marital status, number of dependents, employment, dependent care costs, etc. The IRS previously granted relief from the irrevocability requirement in its May 2020 relief by allowing prospective election changes. Given that the COVID-19 pandemic will cause considerable uncertainty with respect to healthcare costs and dependent care expenses throughout 2021, the Act continues the IRS relief for health and dependent care FSAs for plan years ending in 2021.
The Act’s temporary relief from the FSA use-it-or-lose-it and election irrevocability rules give FSA participants greater flexibility in managing their health and dependent care expenses in a time of uncertainty. However, plan sponsors and administrators should consider the following before adopting the changes:
Plan sponsors considering whether to make these changes and communicate the new rules with their employees should consult with their legal advisors to ensure compliance with applicable laws and regulations.
The foregoing has been prepared for the general information of clients and friends of the firm. It is not meant to provide legal advice with respect to any specific matter and should not be acted upon without professional counsel. If you have any questions or require any further information regarding these or other related matters, please contact your regular Nixon Peabody LLP representative. This material may be considered advertising under certain rules of professional conduct.