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Important COVID-19 Changes to Flexible
by Maineea
Important COVID-19 Changes to Flexible Spending and Dependent Care Accounts
The Internal Revenue Service has recently issued guidance allowing increased flexibility for unused contributions, this plan year, due to COVID-19 in tax-advantaged Health Flexible Spending Arrangements (FSAs) and Dependent Care Assistance Programs (DCAPs).
Both FSAs and DCAPs fall under Section 125 of the Internal Revenue Code and are often referred to as parts of a Section 125 plan or Cafeteria plans. Health FSAs and DCAPs allow employer and employee contributions on a pre-tax basis that can then be used to reimburse the employee for qualifying medical care and dependent care expenses.
Health FSA limits contributions to no more than $2,700 in plan years beginning in 2019, which will be increased to $2,750 for plan years starting in 2020. Individual employer plan limits may be less than the maximum and an employer can contribute up to an additional $500 per year. FSA rules generally require an irrevocable contribution election be made for each plan year. The total amount elected for the year is available to the employee from the first day of the year, but if the employee does not use the elected contribution for expenses during the plan year, the employee loses the remaining contribution subject to two potential caveats. Plans are not required to but can institute either a carryover rule or a grace period, but not both. The carryover rule allows up to $500 of unused funds to be available the next plan year for reimbursement of new expenses. This carryover maximum will be increased to $550 for plan years beginning in 2020. The other option is for a grace period, where all unused funds in one year can be used for new expenses occurring within the first two months and 15 days of the new plan year. Neither of these options is required to be part of the plan, but these options can be negotiated as part of the local collective bargaining agreement.
DCAPs limit contributions to no more than $5,000 per year ($2,500 per parent if married and filing separately), with individual employer plans able to set lower limits. Employers generally can contribute up to the DCAP limit. Unlike Health FSA elections, DCAPs can be structured so that funds are only available as they are accrued. Unused funds are forfeited. Funds cannot be carried over but DCAP plans, like Health FSAs, can have a grace period. Elections are irrevocable, except due to qualifying mid-year change events such as significant changes in the cost of dependent care and working from home so a provider is no longer needed.
HOWEVER…
Given the impacts of COVID-19 that have limited the availability of non-emergent care and changed life patterns for childcare and other dependent care expenses, some employees will have more money in their Health FSAs and DCAPs, based on making an election for the planned expenditures pre-COVID 19, putting employees at risk of losing unused funds. The IRS recently issued new guidance to help individuals who are at risk of losing money. These potential changes are not automatic, however, but they allow the employer’s Section 125 plan document to be changed to allow this relief. The following provisions are now allowed to be part of the Section 125 plan:
Employee contribution elections to Health FSAs and DCAPs can now be changed during 2020 mid-year on a prospective basis. This means, for example, elections can be stopped or reduced to better match expected expenses. If an individual has already been reimbursed for more than they have contributed to an FSA, the reduction cannot be made below the already-reimbursed amount.
Permits employees to apply unused amounts remaining in a Health FSA or DCAP as of the end of the plan year ending in 2020 to new expenses incurred through December 31, 2020.
In addition, the CARES Act passed earlier this year changed the law to expand expenses that can be reimbursed from Health FSAs, as well as Health Reimbursement Arrangements (HRAs) and Health Savings Accounts (HSAs). Again, the employer’s plan document must allow it, but many plan documents may already do this as these expenses have been previously allowable. Over-the-counter drugs can now be reimbursed without a prescription. The definition of medical care was also expanded to include menstrual products, defined as tampons, pads, liners, cups, sponges, or similar products. The expanded language applies to amounts paid, or reimbursements made, after December 31, 2019.
In addition to these allowed plan changes, a carryover provision can also be added to the Health FSA mid-year and be effective for the current year, as long as the plan has neither a carryover or grace period in place. Additionally, for employees retiring or terminating employment this year with unused balances, Health FSA contributions can be accessed through COBRA. Also, the DCAP can provide that unused amounts can be used during the year to pay qualifying expenses after the employee has left.
