Additional Relief under 125 Cafeteria Plans for Employers and Employees

IRS Notice 2021-15 provides clarity for additional relief related to COVID-19 under Cafeteria 125 Plans. The Taxpayer Certainty and Disaster Tax Relief Act of 2020 (the Act) provide temporary rules for health FSAs and dependent care assistance programs that may have been adversely affected due to the pandemic. The amounts properly spent are not subject to federal income tax. Typically, account funds that are not spent by the employee within the plan year, subject to limited grace periods or certain carryover amounts, are forfeited. The law changes outlined below may help mitigate forfeiture situations. Temporary changes under the Act are as follows:

Provides flexibility with respect to carryovers of unused amounts from the 2020 and 2021 plan years

Section 214(b) of the Act provides a similar rule for plan years ending in 2021, permitting the carryover of any unused benefits or contributions from that plan year to the plan year ending in 2022. Thus, an employer, in its discretion, may amend one or more of its § 125 cafeteria plans to provide a carryover of all or part of the unused amounts remaining in a health FSA or a dependent care assistance program as of the end of the plan year ending in 2020 or 2021 to the immediately subsequent plan year.

Example: If an employer-sponsored a calendar year § 125 cafeteria plan in 2020 with a health FSA that provides for a $550 carryover, the employer may amend the plan to carry over the entire unused amount remaining in an employee’s health FSA as of December 31, 2020, to the 2021 plan year (even if that amount exceeds $550). The employer also may amend the plan to carry over the entire unused amount remaining in an employee’s health FSA as of December 31, 2021, to the 2022 plan year. This relief applies to all health FSAs, including HSA-compatible health FSAs, and also applies to all dependent care assistance programs. However, health FSA amounts may be used only for medical care expenses, and dependent care assistance program amounts may be used only for dependent care expenses.

Extends the permissible period for incurring claims for plan years ending in 2020 and 2021

The Act also provides that a plan that includes a health FSA or dependent care assistance program shall not fail to be treated as a cafeteria plan merely because the plan or arrangement extends the grace period for a plan year ending in 2020 or 2021 to 12 months after the end of that plan year, with respect to unused benefits or contributions remaining in a health FSA or a dependent care assistance program.

Example: For example, if an employer-sponsored a calendar year § 125 cafeteria plan in 2020 with a health FSA, the employer may amend the plan to permit employees to apply the entire unused amount remaining in their health FSAs as of December 31, 2020, to reimburse employees for medical care expenses incurred through December 31, 2021.

Provides a special rule regarding post-termination reimbursements from health FSAs during plan years 2020 and 2021;

An employer may also allow employees who have ceased participation in a plan in an earlier plan year to further extend a period for incurring claims until the end of the subsequent plan year under § 214(c)(2). See Notice 2021-15 for further details.

Provides a special claims period and carryover rule for dependent care assistance programs when a dependent “ages out” during the COVID-19 public health emergency; and

Section 214(d)(1) of the Act provides that in the case of certain employees, § 21(b)(1)(A) of the Code shall be applied by substituting ‘‘age 14’’ for ‘‘age 13’’ for purposes of determining the dependent care assistance which may be paid or reimbursed during (A) the last plan year with respect to which the end of the regular enrollment period for such plan year was on or before January 31, 2020, and (B) in the case of an employee who has an unused balance in a dependent care assistance program for such plan year (determined as of the close of the last day on which, under the terms of the plan, claims for reimbursement may be made with respect to such plan year), the subsequent plan year. Only certain employees are eligible for this relief. See IRS Notice 2021-15 for additional guidance.

Example: Employer provides a dependent care assistance program under a § 125 cafeteria plan with a non-calendar plan year. The regular enrollment period for the 2020 plan year (March 1, 2020, through February 28, 2021) ended on January 31, 2020. Employee elected to enroll in the dependent care assistance program for the 2020 plan year, electing to contribute the maximum $5,000 allowed. Employee’s Dependent turns age 13 on February 1, 2021. As of January 31, 2021, Employee has incurred no qualifying expenses for the 2020 plan year. However, the Employee anticipates incurring dependent care expenses during February 2021, which is during the 2020 plan year.

Employer amends its § 125 cafeteria plan by substituting “under age 14” for “under age 13” for the 2020 and 2021 plan years, making that change applicable to all amounts permitted under § 214(d) of the Act, and does not adopt any other relief provided by § 214 of the Act. Employee incurs $5,000 in dependent care expenses in February 2021 for Dependent, who at that time is age 13. The $5,000 in dependent care expenses may be reimbursed by the dependent care assistance program for the 2020 plan year.

Allows certain mid-year election changes for health FSAs and dependent care assistance programs for plan years ending in 2021.

Changes may allow employees, on a prospective basis, to:

(1) revoke an election, make one or more elections, or increase or decrease an existing election, for plan years ending in 2021 regarding a health FSA, or

(2) revoke an election, make one or more elections, or increase or decrease an existing election, for plan years ending in 2021 regarding a dependent care assistance program.

The notice also provides additional relief with respect to mid-year elections for plan years ending in 2021. Specifically, with respect to employer-sponsored health coverage, a § 125 cafeteria plan may permit employees who are eligible to make salary reduction contributions under the plan to take any of the following actions for plan years ending in 2021:

(1) make a new election on a prospective basis, if the employee initially declined to elect employer-sponsored health coverage;

(2) revoke an existing election and make a new election to enroll in different health coverage sponsored by the same employer on a prospective basis; and

(3) revoke an existing election 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.

Summary

The changes under the law are detailed and complex. Please see Notice 2021-15 for full details as the above is a summary.

Jason King, CPA
Jason King, CPA

Jason is a Manager in DMJ’s Wilmington, North Carolina office. Jason works with audit and accounting clients in the manufacturing, construction, pharmaceutical, and retail industries as well as nonprofits. He is also well versed in individual and business taxation and related planning including choice of entity.

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