Ice Miller LLP: Insights

IRS Allows Mid-Year Election Changes for Health Plans, Health FSAs, Dependent Care FSAs in 2020

On May 12, 2020, the Internal Revenue Service ("IRS") issued two notices granting a variety of relief related to cafeteria plan elections for health coverage, medical flexible spending accounts ("health FSAs"), and dependent care flexible spending accounts ("dependent care FSAs").

Notice 2020-29 allows cafeteria plans to: (1) permit participants to make prospective mid-year election changes related to health coverage, health FSAs, and dependent care FSAs; and (2) permit participants to apply amounts in a health FSA or dependent care FSA that are unused as of the end of a grace period or plan year ending in 2020 to pay for or reimburse qualified medical care or dependent care expenses incurred through December 31, 2020. Notice 2020-29 also clarifies that high deductible health plans ("HDHPs") can provide coverage for telehealth services retroactively to January 1, 2020 and that individuals who are in HDHPs who receive telehealth or other remote services without a deductible at any time in 2020 will remain eligible to make contributions to health savings accounts ("HSAs").
Notice 2020-33 increases the carryover limit of a health FSA from $500 to $550.

The mid-year election change guidance will be 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. Employers wishing to adopt these changes have an extended timeframe in which to amend their cafeteria plan documents as long as they provide prompt notice of the changes to all employees who are eligible for the cafeteria plan. Amendments may also be required for group health plans.

Mid-Year Cafeteria Plan Election Changes

Internal Revenue Code ("Code") Section 125 governs cafeteria plans and generally requires cafeteria plan elections (including health FSA and dependent care FSA elections) to be irrevocable during a plan year. As a result, employers generally hold an open enrollment prior to the start of a plan year during which employees elect benefits, including making pre-tax elections to pay health plan premiums and making pre-tax contributions to health FSAs and dependent care FSAs. Once these elections are made they cannot be changed unless mid-year election change events occur. Typical events include getting married or divorced, having a child, gaining or losing eligibility under a plan due to an employment event, or situations when the cost or coverage of benefit plans changes. These events are very limited and are set out in the Code Section 125 regulations.

As a result of the current COVID-19 public health emergency, situations have arisen where plan participants want to change their benefit elections, but they have not experienced one of the limited events in the Code Section 125 regulations that allow for mid-year election changes. For example, an employee may have based her 2020 health FSA election on an anticipated elective medical procedure this year. However, in many states, elective procedures have been cancelled or limited. Even as elective procedures become available again, the employee may be reluctant to get the procedure in a medical facility. The employee would like to reduce her FSA election to reflect the fact she will not be getting the elective procedure this year. Perhaps another employee did not elect health plan coverage for 2020, but now finds he needs it due to contracting COVID-19. Yet another employee may have overestimated her child care expenses in electing her dependent care FSA contribution because she did not know she would be on furlough for several months in 2020 and would not need child care.

To address these and other situations, the IRS's guidance in Notice 2020-29 greatly expands the mid-year election change events for 2020. An employer may amend its cafeteria plan to allow employees to:

make a new election for employer-sponsored health coverage on a prospective basis, if the employee initially declined to elect employer-sponsored health coverage;
revoke an existing election for employer-sponsored health coverage and make a new election to enroll in different health coverage sponsored by the same employer on a prospective basis (including changing enrollment from self-only coverage to family coverage);
revoke an existing election for employer-sponsored health coverage 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 (Notice 2020-29 provides a sample attestation);
revoke an election, make a new election, or decrease or increase an existing election regarding a health FSA on a prospective basis; and
revoke an election, make a new election, or decrease or increase an existing election regarding a dependent care FSA on a prospective basis.

An employee taking advantage of these election change opportunities does not have to provide a reason for making the change, nor does the employee have to demonstrate that he or she was directly affected by COVID-19 in some way. The election change can be made for any reason.

The election changes may only be prospective. In other words, an employee may not seek a refund of contributions that have already been made to a health FSA or a dependent care FSA.

Notice 2020-29 makes clear that an employer may adopt some, all, or none of these election changes. Moreover, in order to manage adverse selection, the Notice allows an employer "to limit election changes to circumstances in which an employee's coverage will be increased or improved as a result of the election (for example, by electing to switch from self-only coverage to family coverage, or from a low option plan covering in-network expenses only to a high option plan covering expenses in- or out-of-network)." In addition, employers are allowed to limit health FSA and dependent care FSA election changes to amounts no less than the amount already reimbursed. This will protect employers from employees who have already been reimbursed up to their annual elections who now want to reduce their salary contributions to zero.

Notice 2020-29 allows the application of this relief retroactively to January 1, 2020, if a cafeteria plan permitted mid-year elections consistent with the Notice prior to issuance of the Notice.

Extended Claims Period for FSAs and DCAPs

Notice 2020-29 also allows an employer to amend its cafeteria plan to allow employees to use amounts remaining in a health FSA or dependent care FSA after the end of a grace period or plan year that ends in 2020 to pay or reimburse expenses incurred through December 31, 2020. For example, if an employee has $400 remaining unused in his health FSA at the end of the 2019 grace period that ended on March 15, 2020, the employer may allow the employee to use that $400 for medical expenses that the employee incurs through December 31, 2020. Similarly, if an employee has an unused balance of $600 in a dependent care FSA at the end of a plan year ending June 30, 2020, the employer may allow the employee to use that $600 for dependent care expenses incurred through December 31, 2020. This relief applies to general purpose FSAs, limited purpose FSAs, and dependent care FSAs.

Employers adopting this extended claims period should exercise caution if they sponsor an HDHP. The extended period in a general-purpose FSA is an extension of coverage that is not an HDHP for purposes of determining an employee's eligibility to make contributions to a HSA. Therefore, an employee who had unused amounts remaining at the end of the grace period ending in 2020 and who is allowed to use those funds for expenses incurred through December 31, 2020 will not be eligible to make HSA contributions for the remainder of 2020.

Plan Amendments

Normally, an amendment must be made to a cafeteria plan before a change can take effect. However, in Notice 2020-29, the IRS stated it will allow cafeteria plans to be amended for the 2020 plan year to adopt the expanded mid-year election changes and/or the extended claims periods for health FSAs and dependent care FSAs on or before December 31, 2021. Those amendments may be retroactive to January 1, 2020, as long as the cafeteria plan operates in accordance with Notice 2020-29, and the employer informs all employees who are eligible to participate in the cafeteria plan of the changes. Employers that adopt the election changes allowed for group health plans should also review their group health plan document to determine whether amendments need to be made to that document to allow for mid-year enrollments and changes.

HDHP Relief

In Notice 2020-15, the IRS provided relief so HDHPs could cover medical services and items relating to testing and treatment for COVID-19 prior to the satisfaction of the HDHP's deductible. Notice 2020-29 clarifies that this relief applies to such medical services and supplies incurred on or after January 1, 2020.

In addition, relief provided under the Coronavirus Aid, Relief, and Economic Security Act ("CARES Act") temporarily allows individuals to remain eligible to make contributions to HSAs if they are covered under an HDHP that provides telehealth or other remote care services without a deductible or if they otherwise have access to telehealth or other remote care services outside of an HDHP. Notice 2020-29 provides that this relief applies retroactively to January 1, 2020. Thus, an individual who is otherwise eligible to make contributions to an HSA with coverage under an HDHP who also received coverage at any time after January 1, 2020 for telehealth and other remote care services under the HDHP or outside of the HDHP, and before satisfying the deductible under the HDHP, will still be able to make HSA contributions.

Notice 2020-33

Since 2013, employers have been allowed to amend their cafeteria plans to permit participants to carry over up to $500 of unspent health FSA funds into the next plan year. This "carryover" feature is not required and a cafeteria plan cannot have both a carryover feature and a grace period in the same plan year.

When the carryover feature was announced in Notice 2013-71, it was limited to $500 with no automatic increases. Notice 2020-33 adds an automatic increase so the maximum carryover amount will be 20% of the maximum salary reduction contribution that an individual can make to a health FSA (which is indexed to inflation). As a result, the maximum amount that can be carried over from the 2020 health FSA plan year into the 2021 health FSA plan year will be $550 (20% of $2,750, the indexed maximum health FSA salary reduction contribution limit for 2020).

Employers that wish to adopt the increased limit (either explicitly or by reference) for 2020 have until December 31, 2021, to amend their cafeteria plan, provided the employer informs all employees who are eligible to participate in the cafeteria plan of the change. Note that if an employer adopts the newly permissive mid-year election change rules for health FSAs described above, an employee could increase a health FSA election to take advantage of the increased carryover amount.

For more information, please contact Chris Sears, Kathleen Sheil Scheidt, Melissa Proffitt, Tara Sciscoe, Shalina Schaefer, Gary Blachman, Rob Gauss, Audra Ferguson-Allen, Austin Anderson, or the Ice Miller LLP Employee Benefits attorney with whom you work.

This publication is intended for general information purposes only and does not and is not intended to constitute legal advice. The reader should consult with legal counsel to determine how laws or decisions discussed herein apply to the reader's specific circumstances.