Last week, the Department of the Treasury (“Treasury”) and the IRS issued two notices designed to provide tax relief by providing increased flexibility for health and welfare plans:
- Notice 2020-29 is specific to the COVID-19 pandemic, and offers increased flexibility with respect to mid-year elections under Internal Revenue Code Section 125 cafeteria plans, including health flexible spending accounts (“health FSAs”) and dependent care assistance programs (“DCAPs”).
- Notice 2020-33 is not specific to the COVID-19 pandemic. Notice 2020-33 modifies the carryover rule under health FSAs and clarifies reimbursements of individual policy premiums by individual coverage health reimbursement arrangements (“HRAs”).
In Notice 2020-29, the IRS and Treasury recognized that COVID-19 has led to “unanticipated changes in the need for medical care” and a desire on the part of some employers to provide assistance in meeting employees’ needs with respect to those changes. In addition, as a result of COVID-19, employees may have an unanticipated increase or decrease in the need for dependent care assistance. Accordingly, the IRS and Treasury issued Notice 2020-29 to provide flexibility with respect to employer-sponsored health and welfare plans.
Mid-Year Cafeteria Plan Elections
A “cafeteria plan” is a tax vehicle that allows employees to choose between two or more benefits, generally consisting of taxable cash and pre-tax qualified benefits. For example, an employee may choose between receiving his or her full salary in cash or electing instead to use a portion of such salary to pay, on a pre-tax basis, his or her employee share of health plan premiums under his or her employer-sponsored health plan. Elections under a cafeteria plan for a plan year are generally irrevocable except in certain circumstances described in applicable Treasury Regulations. Notice 2020-29 permits (but does not require) an employer to amend its cafeteria plan to allow certain prospective mid-year election changes outside of the changes otherwise permitted under the applicable Treasury Regulations, as follow:
- Employees who initially declined to elect employer-sponsored health coverage may elect to enroll in employer-provided health coverage.
- Employees may revoke an existing election for employer-sponsored health coverage and make a new election to enroll in a different employer-sponsored coverage option. For example, an employee who elected employee-only coverage may elect family coverage. To the extent an employer permits employees to enroll in a different coverage option, the IRS and Treasury warn employers to “consider the potential for adverse selection of health coverage” – i.e., employers should be careful that employees are not revising their elections to move to a cheaper option that may not cover the employees’ healthcare needs. The IRS and Treasury recommend that employers limit this mid-year election change to circumstances in which an employee’s coverage will be increased or improved.
- Employees may revoke an existing election for employer-sponsored health coverage. However, an employee wishing to do so must attest in writing that he or she is enrolled, or will immediately enroll, in other coverage not sponsored by the employer. The employer can rely on the employee’s written attestation (which does not have to be notarized), unless the employer has actual knowledge that the employee does not have, and will not enroll in, other coverage.
- Employees may revoke an election, make a new election, or decrease or increase an existing election under a health FSA
- Employees may revoke an election, make a new election, or decrease or increase an existing election under a DCAP.
The amendments permitted under Notice 2020-29 are permitted with respect to both self-insured and fully-insured plans. In addition, the relief applies to all health FSAs, including limited-purpose health FSAs. All participant elections made pursuant to Notice 2020-29 must be prospective, but the relief provided under Notice 2020-29 applies to any elections permitted by a cafeteria plan beginning on January 1, 2020. Therefore, if, prior to the issuance of Notice 2020-29, a plan sponsor permitted a mid-year cafeteria election that otherwise satisfies the requirements of Notice 2020-29, the plan can be retroactively amended to satisfy Notice 2020-29.
Extended Period for Health FSAs and DCAPs
Under existing law, unused amounts in a health FSA or DCAP must be forfeited at the end of a plan year unless, with respect to a health FSA, the applicable cafeteria plan provides for a “carryover amount” or, with respect to a health FSA or DCAP, the cafeteria plan provides for a “grace period.” Health FSAs can generally provide either for a “grace period” or a “carryover amount,” but not both. A “grace period” is a period of time after the end on the plan year (no longer than 2 months and 15 days into the next plan year) during which the participant may use any unused amounts in his or her account. For example, for a calendar year plan year, if a participant has $200 in his or her health FSA on December 31, 2020, the participant has until March 15, 2021 to incur expenses and submit claims with respect to that $200. A “carryover amount” is an amount set by the plan (generally limited to $500, but see Notice 2020-33, described below) that, if not used in the plan year, can be “carried over” and used in the next plan year.
Notice 2020-29 provides that, due to “the nature of the public health emergency posed by COVID-19, in particular unanticipated changes in the availability of certain medical care and dependent care,” employees may be more likely have unused amounts in their health FSAs and DCAPs. Accordingly, employers may (but are not required to) amend their cafeteria plans to permit employees to apply unused amounts in a health FSA or DCAP at either the end of a grace period ending in 2020 or the end of a plan year ending in 2020 to pay or reimburse expenses incurred through December 31, 2020. This extended claim period would apply from January 1, 2020 through December 31, 2020.
Under current law, employees cannot contribute to both a health FSA and a health savings account (“HSA”), unless the health FSA is a “limited purpose” health FSA. Notice 2020-29 provides that an individual who is allowed an extended period to incur claims and expenses under a health FSA will not be permitted to contribute to a HSA, unless the health FSA is a “limited purpose” health FSA.
Plan amendments with respect to the provisions of Notice 2020-29 must be adopted by December 31, 2021.
In June of 2019, the President issued Executive Order 13877, directing the Secretary of the Treasury to issued guidance to increase the amount that participants can carryover at the end of the year under health FSAs. Notice 2020-33 was issued in response to that Executive Order.
Health FSA Carryovers
As described briefly above, an employer can permit a participant in a health FSA to carry over $500 at the end of a plan year. Notice 2020-33 increases the $500 carryover limit to an amount equal to 20% of the maximum health FSA salary reduction contribution for that plan year. The health FSA salary reduction amount is set by the Internal Revenue Code and indexed for inflation. For example, the 2020 health FSA salary reduction amount is $2,750. Therefore, under Notice 2020-33, the amount that can be carried over to 2021 is $550.
Pursuant to Notice 2020-33, an employer who wants to provide the increased carryover generally must amend the plan on or before the last day of the plan year from which amounts may be carried over. However, amendments for the 2020 plan year need not be adopted until December 31, 2021.
Individual Coverage HRAs
Individual coverage HRAs are HRAs under which employers may provide contributions for employees to use to purchase health care coverage in the individual health insurance market or the Marketplace. Notice 2020-33 provides clarification with respect to taxation and timing of contributions to an individual coverage HRA, by providing that an individual coverage HRA is permitted to treat an expense for a health insurance premium as incurred on (1) the first day of each month of coverage on a pro rata basis, (2) the first day of the period of coverage, or (3) the date the premium is actually paid.
If you have any questions regarding the notices, please contact a member of Arnall Golden Gregory’s Employee Benefits team.