IRS Issues Section 125 Plan Relief to Address COVID-19 Concerns

Consistent with prior notices offering relief for plan sponsors and participants due to the COVID-19 pandemic, the Internal Revenue Service (IRS) issued Notices 2020-29 and 2020-33 on May 12 to address a number of questions and concerns related to the impact of COVID-19 pandemic on cafeteria plan elections for health coverage, health flexible spending accounts (health FSAs) and dependent care flexible spending accounts (dependent care FSAs) (collectively, health FSAs and dependent care FSAs are referred to as FSAs in this alert). In particular, this guidance provides the following relief:

• Provides increased flexibility to make midyear election changes for the 2020 calendar year;
• Gives participants more leeway with respect to grace periods and carryover amounts in health and dependent care FSAs;
• Clarifies that high deductible health plans (HDHPs) can cover medical services and items relating to testing and treatment for COVID-19 and provide coverage for telehealth services retroactively to January 1, 2020, without affecting HSA eligibility; and
• Increases the health FSA carryover amounts for 2020 and future years.

Each of these changes is discussed in more detail below.

Midyear Election Changes

Due to the unexpected changes brought by the COVID-19 pandemic, the IRS has temporarily relaxed some restrictions on midyear election changes during 2020. Notice 2020-29 provides flexibility for Section 125 cafeteria benefit plans (referred to in this alert as Section 125 plans) to permit employees to make certain prospective midyear election changes for health coverage, health FSAs and dependent care FSAs during calendar year 2020. These changes include:

• Enrolling in coverage. If an eligible employee previously declined coverage, he or she may make a new election for employer-sponsored health coverage.
• Dropping current health coverage to enroll in a different coverage option offered by the same employer or to change coverage levels (g., single to family coverage).
• Dropping health coverage under the employer-sponsored plan, but only upon certification that the employee will enroll in other health coverage. The employer can rely on an attestation by the employee as to intent to enroll in other coverage as long as the employer doesn’t have actual knowledge to the contrary.
• Enrolling in an FSA, dropping FSA coverage or increasing or decreasing an existing FSA election. These changes apply to both health and dependent care FSAs. In addition, employers are allowed to limit FSA election changes to amounts no less than the amount already reimbursed, in order to prevent employees who have already been reimbursed up to their annual elections from then reducing their salary contributions to zero.

Notably, these changes to the midyear election rules are discretionary, and an employer may choose to adopt all, some or none of these changes. In addition, to limit adverse selection, Notice 2020-29 allows employers to limit election changes to increases or improvements in coverage—for example, switching from self-only to family coverage, or from a plan that covers only in-network benefits to one that covers both in- and out-of-network benefits.

The IRS notes that even though plans may be amended to permit prospective election changes only, to the extent employers were already permitting any of the sorts of changes described above, the plan can be amended retroactively to January 1, 2020, to ratify those election changes if they otherwise would be in compliance with the Notice 2020-29. Any amendment to midyear election rules for 2020 must be adopted no later than December 31, 2021. This is notable because the proposed Section 125 plan regulations state that retroactive amendments are impermissible.

Extended FSA Claims Period for 2020

Generally, with respect to a health FSA, a Section 125 plan may either (1) permit the carryover of up to $500 of unused amounts remaining as of the end of a plan year to pay for or reimburse expenses incurred during the following plan year or (2) provide a grace period of up to 2½ months after the end of a plan year for a participant to apply unused amounts of the health FSA to pay for qualified expenses. Similarly, Section 125 plans may also offer a grace period (but not a carryover) for dependent care FSAs.

Notice 2020-29 allows employers to amend their Section 125 plans to permit employees to apply unused health and dependent care amounts as of the end of a plan year or grace period ending in 2020 to pay or reimburse expenses incurred for the same type of FSA through December 31, 2020.

For example, if a calendar year health FSA provides for a 2½-month grace period following its 2019 plan year, the employer could amend the plan to provide that any unused amounts in the FSA as of March 15, 2020 (the last day of the grace period) could be used to pay or reimburse the employee for health care expenses incurred through December 31, 2020.

Similarly, a health or dependent care FSA with a non-calendar-year plan year could be amended to allow any unused amounts from the plan year ending in 2020 (including amounts greater than $500 subject to carryover) to be used to pay or reimburse health or dependent care expenses, as applicable, incurred during the remainder of the 2020 calendar year.

This relief only appears to apply to plans with a non-calendar-year plan year, or calendar-year plans that provide for a grace period. Calendar-year plans with no grace period do not appear to be able to take advantage of this relief.

The IRS notes that employers adopting this extended claims period should exercise caution if they sponsor an HDHP with an HSA. 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 an 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.

If an employer wishes to provide for extended FSA claims periods during 2020, the Section 125 plan must be amended no later than December 31, 2021.

HDHP/HSA Clarifications

Notice 2020-29 also clarifies the relief provided under Notice 2020-15 and the CARES Act regarding HDHPs. (For our alert describing the relief available under Notice 2020-15 and the CARES Act, click here.) In particular, Notice 2020-29 clarifies the following:

• 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 deductible but retain compatibility with HSAs. Notice 2020-29 clarifies that the guidance is applicable on a retroactive basis to January 1, 2020. It further clarified that coverage for any COVID testing or supply services required to be covered at no cost under the CARES Act will not impact HSA eligibility.
• The CARES Act permitted plans to provide free telehealth services with no cost sharing through December 31, 2020 (whether COVID-related or not) without impacting HSA eligibility. Even though the CARES Act was not passed until March 27, 2020, Notice 2020-29 clarifies that this relief will be applied retroactively to January 1, 2020.

Increased Health FSA Carryovers

Notice 2020-33 provides a permanent indexing feature to the allowable carryover of unused health care FSA balances from one plan year to the next. Under prior IRS guidance, Section 125 plans were permitted to adopt a carryover provision allowing up to $500 of unused amounts to carry forward for use in a subsequent plan year. This amount was not adjusted for inflation. Pursuant to Notice 2020-33, starting for plan years that begin on or after January 1, 2020, the carryover amount is indexed. A plan that adopts a carryover provision can allow participants to carry over up to $550 from the plan year that begins during 2020 into the 2021 plan year. Presumably, this amount will increase in subsequent years.

Next Steps

Employers will want to consider whether or not to adopt some or all of the changes permitted under Notice 2020-29 with respect to midyear election changes and the extended FSA claims period. To the extent an employer wishes to implement changes, the Section 125 plan must be amended by December 31, 2021. In addition, while not specifically mandated in Notice 2020-29, employers implementing any changes will want to consider how best to communicate changes to eligible employees. If you have any questions about these new Section 125 plan options, please contact any of the employee benefits and executive compensation attorneys listed here for assistance.