As the pandemic continues, your employees may still experience restricted access to medical care or be forced to delay elective medical procedures. Their children may still be at home, with dependent care centers closed for all or part of the year. Many people are still working from home instead of commuting to an office. Just as in 2020, these realities can reduce the value of calendar-year-plan healthcare flexible spending accounts (FSAs) and dependent care assistance plans (DCAPs).
In response and to help people receive the full value of their elections, the IRS loosened some of the rules governing these benefits. The IRS is clear that making any of these changes is entirely up to the employer’s discretion. This guide discusses the ins and outs of implementation for employers who choose to adopt one or more of these changes.
Healthcare FSAs and DCAPs are “use it or lose it” plans, meaning any funds remaining in these accounts at the end of the plan year are forfeited. Typically, a runout period is implemented through the first quarter following the plan year, which allows employees to submit claims incurred in the prior year against the previous year’s funds. In some cases, an employer might allow a grace period of an additional 2.5 months to incur healthcare and dependent care expenses or allow a healthcare FSA to carry over amounts of up to $550 to flow into the next year’s plan. In any case, employees are locked into the amount they elected when they enrolled, with no midyear changes allowed — unless there’s a change in family status (e.g., birth, divorce, marriage or death).
The IRS recently changed the rules governing these accounts due to the impact of COVID-19 on people’s ability to use their FSA and DCAP funds. These changes address:
For calendar year 2021, employers may permit employees who have been making salary reduction contributions to an FSA or DCAP to make midyear election changes. They can:
Employers are permitted to limit midyear elections to amounts no less than amounts already contributed and/or reimbursed in 2021. If, for example, an employee’s original election was $1,000 and it now looks like the employee will only spend $500, he or she may reduce the election to $500.
Recently, the IRS provided guidance on reimbursements for nonprescription, over-the-counter personal protective equipment (PPE) that had been a source of confusion since the start of the COVID-19 pandemic.
In Announcement 2021-7 the IRS clarified that purchases of PPE, such as face masks, hand sanitizer and sanitizing wipes, for the primary purpose of preventing the spread of coronavirus are also eligible to be paid or reimbursed under healthcare FSAs, health savings accounts (HSAs) or health reimbursement arrangements (HRAs).
For calendar year 2020 healthcare FSAs and DCAPs, the grace period would typically have ended on March 15 of the following year (2021). The IRS now allows employers to extend the grace period until December 31 of the following year. This means the grace period for the 2020 plan year can be extended to December 31, 2021. The same grace period extension also applies to the 2021 plan year. Employers can choose not to extend the grace period, or they can choose an earlier date for closing the grace period if they so wish.
If the employer chooses to adopt these changes, unused amounts in healthcare FSAs and DCAPs as of the end of the grace period for plan year 2020 can be reimbursed until December 31, 2021.
Even if an employer chooses not to extend the grace period, the IRS has mandated that the claim filing period for healthcare FSAs (and HRAs) be extended until 60 days after the announced end of the declared presidential national emergency, or until one year after the plan’s original deadline, whichever comes sooner. If, for example, a plan’s original deadline to submit was March 31, 2021, then unless the presidential national emergency has ended, requests need to be submitted by March 31, 2022. This extension also applies to appeals of denied claims.
There are limits on HSA contributions for employees with unused amounts at the end of the 2020 plan year with a grace period ending in 2021. If an employer’s plan gives an extended grace period to incur expenses under its FSA, employees may not also contribute to an HSA during the extended period. HSA-compatible healthcare FSAs, such as limited-purpose or post-deductible healthcare FSAs, are exceptions to this rule.
The healthcare FSA carryover amount, previously limited to a maximum of $500, was increased to a maximum of $550 in 2020. Note that the increase to the FSA carryover amount was not related to the COVID-19 pandemic. The new carryover maximum of $550 will continue to be in place after the 2021 plan year.
The Consolidated Appropriations Act, 2021 (CAA) provides additional flexibility to employers related to healthcare FSA carryover. The CAA provides employers the ability to allow full carryover of healthcare FSA remaining balances for the 2020 and/or 2021 plan years. This means employers could allow maximum flexibility to their employees, eliminating the “use it or lose it” provision for the 2020 and/or 2021 plan years.
The CAA also provides employers with additional flexibility related to DCAP carryover, allowing a full carryover of DCAP remaining balances for the 2020 and/or 2021 plan years. This means employers could allow maximum flexibility to their employees, eliminating the “use it or lose it” provision for the 2020 and/or 2021 plan years.
Note that carryover of dependent care balances was previously not allowed and is temporary, as it only applies to the 2020 and/or 2021 plan years. This means employers may permit carryover from 2020 into 2021 and/or 2021 into 2022.
The annual limit on contributions for DCAPs was increased for 2021 to $10,500. Adopting this increase is optional and currently limited to the 2021 plan year. The annual limit on contributions for 2022 will revert back to $5,000.
Additionally, the IRS addressed the tax implications for 2020 and 2021: An election that qualified as nontaxable will remain nontaxable when carried over to the next year, including the amount in the employee’s DCAP that is over the annual limit. Additionally, the carryover amount will not affect current plan year contribution limits. This means that employees will not be taxed on a carryover balance from 2020 if the balance is used during the 2021 plan year. The same applies for a 2021 balance carried over into the 2022 plan year.
As an example, a $5,000 carryover from 2020 to 2021 would not count against the maximum amount that may be contributed in 2021 (up to $10,500), and the entire balance of $15,500 would be nontaxable if used for dependent care benefits.
Employers can choose not to adopt any of these changes; they are discretionary. They can also pick and choose the changes they want to make and set the period during which changes are in force.
Employers that choose to implement these changes need to understand how their claim administrator is managing grace period and runout extensions, and communicate the changes to their employees. Employers will also need to reflect any changes in a summary of material modifications or summary plan description and monitor to ensure system changes are implemented. All changes must be communicated to employees as soon as possible after decisions are made. Formal written amendments for plan year 2020 must be completed by December 31, 2021, and amendments for plan year 2021 must be completed by December 31, 2022.
For employees, these changes can reduce or erase the negative impact of COVID-19 on the value of their benefits. This added flexibility for using funds in these accounts can decrease amounts that would have otherwise been forfeited.
