On May 12, 2020, the IRS issued two new Notices which provide temporary changes to the rules governing Section 125 cafeteria plans and flexible spending accounts through 2020 due to COVID-19 pandemic, and permanent changes to health flexible spending accounts (“health FSAs”) that will begin this year.

Temporary changes to cafeteria plan rules

IRS Notice 2020-29 enables Section 125 cafeteria plans to provide for increased flexibility to participants during calendar year 2020 with respect to mid-year elections for employer-sponsored health coverage, health FSAs, and dependent care flexible spending accounts (“dependent care FSA”). The mid-year election change guidance can provide a relief to plan participants who did not anticipate the COVID-19 crisis when making their health plan, health FSA, and dependent care FSA elections for 2020.

The long-standing basic rule for Section 125 cafeteria plans is that participant elections must be made before the start of the plan year and generally must be irrevocable for the remainder of the plan year unless the participant qualifies for an exception. However, Notice 2020-29 permits a cafeteria plan to allow the following prospective mid-year election changes made during calendar year 2020:

1. With respect to employer-sponsored health coverage, participants may:
   1. make a new election on a prospective basis, if the employee initially declined to elect employer-sponsored health coverage;
   2. 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
   3. 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, such as another group health plan, Medicaid, Medicare, or individual health coverage.
2. With respect to a health care FSA or dependent care FSA, participants may revoke an election, make a new election, or decrease or increase an existing election on a prospective basis.

An employee taking advantage of these election change opportunities does not have to provide a reason for making the change.

These new temporary rules are applicable only to 2020 and are optional, not mandatory. In deciding whether to adopt the temporary rules, Employers should consider the potential for adverse selection and whether their medical plan insurer, or in stop-loss insurer in the case of self insured plans, will agree to allow participants this additional flexibility to change their elections.

The Notice also provides that for unused amounts remaining in a health FSA or a dependent care FSA under the Section 125 cafeteria plan as of the end of a grace period or plan year ending in 2020, the Section 125 cafeteria plan may permit employees to apply those unused amounts to pay or reimburse medical care expenses or dependent care expenses, respectively, incurred through December 31, 2020.

If an employer wishes to utilize any of these optional provisions provided in the Notice 2020-29, it must amend its plan document by no later than December 31, 2021, and the amendment can be retroactive to January 1, 2020.

Permanent changes to health FSA carryover amount

IRS Notice 2020-33 for the first time provides a permanent indexing feature to the limit for allowable carryover of unused health care FSA balances from one plan year to the next. Until the recent change, health FSAs could allow a carryover of up to $500 of unused health balances for use in the next plan year, without reducing the overall amount that a participant could elect to contribute for that next year. Starting for plan years that begin on or after January 1, 2020, the carryover amount is indexed. Thus, a plan that has a carryover provision can be amended to allow for up to $550 from the plan year that begins during 2020 into the 2021 plan year.

Action steps

• Because the new rules regarding mid-year election changes and extension of period for health FSA claims are temporary, a quick decision is necessary. Be sure to coordinate with all applicable insurance carriers, stop-loss providers, and FSA TPAs. If you elect the new provisions:
  • Inform employees of ability to make election changes and/or ability to incur claims through December 31, 2020
  • Amend the cafeteria plan no later than December 31, 2021
  • Amendment to the employer’s medical plan document may also be necessary
• If your cafeteria plan includes a health FSA carryover, consider whether to adopt the indexed limit
  • Plan must be amended by December 31, 2021
  • Provide notice to employees