IRS Provides Section 125 Plan Participants Relief Through Increased Flexibility

May 18, 2020

By Peter Alwardt

On May 12, 2020, the Internal Revenue Service released guidance through Notices 2020-29 and 2020-33 (“Notice” or “Notices”) to allow temporary changes to IRC Sec. 125 cafeteria plans.  These changes extend the claims period for health flexible spending arrangements (“FSAs”) and dependent care assistance programs and allow participants to make mid-year changes to spending elections.  Further, the Notices address unanticipated changes in expenses due to the 2019 novel coronavirus (“COVID-19”) pandemic and provide that previously provided temporary relief for high deductible health plans may be applied retroactively to January 1, 2020.  They also increase the $500 permitted carryover amount for health FSAs for inflation to $550.  Finally, employers are not required to offer nor make these temporary changes to their IRC Sec. 125 plans.

The Notices

Notice 2020-29

This Notice provides greater flexibility to participants by:

  1. Extending claims periods for participants to apply unused amounts remaining in a health FSA or dependent care assistance program for expenses incurred for those same qualified benefits through December 31, 2020.
  2. Expanding the ability of participants to make mid-year elections for health coverage, health FSAs, and dependent care assistance programs, allowing them to respond to changes in needs as a result of the COVID-19 pandemic.
  3. Applying earlier relief for high deductible health plans to cover expenses related to COVID-19, and a temporary exemption for telehealth services retroactively to January 1, 2020.

Specifically, for unused amounts remaining in a health FSA or a dependent care assistance program under an IRC Sec. 125 cafeteria plan as of the end of a grace period or plan year ending in 2020, an IRC Sec. 125 cafeteria plan may (an employer is not required to offer these changes or amend its plan to provide for these changes) permit employees to apply those unused amounts to pay or reimburse medical care expenses or dependent care expenses, respectively, incurred through December 31, 2020.

For mid-year elections made during calendar year 2020, an IRC Sec. 125 cafeteria plan may (an employer is not required to offer these changes or amend its plan to provide for these changes) permit employees who are eligible to make salary reduction contributions under the plan to: 

  1. With respect to employer-sponsored health coverage, (a) make a new election on a prospective basis, if the employee initially declined to elect employer-sponsored health coverage; (b) revoke an existing election and make a new election to enroll in different health coverage sponsored by the same employer on a prospective basis; and (c) revoke an existing election on a prospective basis, provided that the employee attests in writing that the employee is enrolled, or immediately will enroll, in other health coverage not sponsored by the employer;
  2. Revoke an election, make a new election, or decrease or increase an existing election applicable to a health FSA on a prospective basis; and
  3. Revoke an election, make a new election, or decrease or increase an existing election regarding a dependent care assistance program on a prospective basis.
  4. The relief provided in Notice 2020-15 regarding high deductible health plans and expenses related to COVID-19 and in the CARES Act regarding an exemption for telehealth services may be applied retroactively to January 1, 2020.

Notice 2020-33

This Notice was issued in response to Executive Order 13877, which directed the Secretary of the Treasury to “issue guidance to increase the amount of funds that can carry over without penalty at the end of the year for flexible spending arrangements.” The Notice increases the limit that an IRC Sec. 125 plan may provide for unused health FSA carryover amounts retroactively to January 1, 2020 from $500 to a maximum of $550, as adjusted annually for inflation.  It is important to note that the employer is not required to allow a carryover of annual FSA amounts and if they do allow carryovers, they can limit the amount to less than the maximum provided above.

Plan Amendments

An employer that decides to amend its IRC Sec. 125 cafeteria plan in a manner consistent with Notice 2020-29 to provide for mid-year election changes for employer-sponsored health coverage, health FSAs, or dependent care assistance programs or to provide for an extended period to apply unused amounts remaining in a health FSA or a dependent care assistance program to pay or reimburse medical care expenses or dependent care expenses must adopt a plan amendment.  In addition, an employer that decides to amend its health FSA to provide for an increase in the carryover of unused amounts to the following year in a manner consistent with Notice 2020-33, for the 2020 plan year or plan years thereafter, must adopt a plan amendment.

An amendment for the 2020 plan year must be adopted on or before December 31, 2021, and may be effective retroactively to January 1, 2020, provided that the IRC Sec. 125 cafeteria plan operates in accordance with the Notice(s) and the employer informs all employees eligible to participate in the IRC Sec. 125 cafeteria plan of the changes being made to the plan. Any amendment adopted pursuant to Notice 2020-29 must apply only to mid-year elections made during calendar year 2020 or to an extended period to apply unused health FSA amounts or dependent care assistance program amounts for the payment or reimbursement of medical care expenses or dependent care expenses incurred through December 31, 2020.

Conclusion

In deciding whether to implement some or all the provisions of the Notices, employers will want to carefully consider the cost and ability to implement administrative requirements of notifying employees of the changes and providing a mechanism for mid-year elections to be made and implemented versus the temporary nature of the relief being provided.

About Peter Alwardt

Peter Alwardt is a Tax Partner specializing in employee benefits, tax and ERISA issues for domestic and international clients. He is a member of the American Institute of Certified Public Accountants and NY State Society of CPAs.