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IRS Increases Flexibility for Section 125 Cafeteria Plan

Posted by Admin Posted on June 02 2020

As part of their response to the COVID-19 health crisis, the Internal Revenue Service (IRS) released two notices providing additional flexibility for employers who maintain Internal Revenue code (IRC) section 125 cafeteria plans for their employees.

On May 12, 2020, the IRS released Notice 2020-29 and Notice 2020-33 to help taxpayers address anticipated health and dependent care expenses due to the coronavirus pandemic.

Under this collective guidance, employers have the option to amend their section 125 cafeteria plans and flexible spending accounts (FSAs) to allow employees to make prospective midyear election changes, regardless of the reason, during calendar year 2020.


 

 
 
 
 
 
 
 

Background

 

The general rule is employee elections for pre-tax payment of employer-sponsored health coverage, health FSAs and dependent care assistance programs (DCAPs) must be made prior to the first day of the plan year. These elections are irrevocable for the plan year unless the employee experiences a permitted change in status or there are significant changes in the cost of coverage. This requirement includes an affirmative election to participate or a default election not to participate.

Also, employees enrolled in health FSAs and DCAPs generally forfeit unused amounts after the plan year comes to an end. This is widely known as the “use it or lose it” rule. Some health FSAs allow a grace period (not to exceed 2 ½ months after the end of the plan year) during which they may use amounts deferred in the prior year, or a carryover of up to $500. However, plans generally do not permit both the grace period and carryover.


 

 
 
 

How has COVID-19 impacted section 125 health coverage?

 

Now, due to the COVID-19 pandemic, the amount of pre-tax salary deferrals elected by many employees into the section 125 cafeteria plans have not matched their needs. For example, with most U.S. schools and day care centers closed since mid-March, many employees are not paying qualifying child care expenses and therefore will not incur the expenses they projected when they made their health plan elections. Similarly, employees who had to postpone scheduled medical procedures might have contributed more to their health FSAs than they can spend.

The significant impact of COVID-19 on the personal lives of employees may leave many wishing to adjust their health plan coverage for the year. For instance, they may wish to reduce future salary reductions due to a decrease in incurred qualifying expenses. Employees who experienced a furlough or reduced working hours might need to make a less expensive election for the remainder of the plan year. On the other hand, employees who contract the virus may incur extraordinary expenses and need increased benefits.

Therefore, without certain allowances from the authorities, many section 125 plan participants are unable to make mid-year adjustments to their health coverage to better suit their current needs. This is where Notice 2020-29 and Notice 2020-33 come into play.

We analyzed both notices and outlined the key points below.


 

 
 
 

Notice 2020-29

 

Mid-year changes for 2020

Per Notice 2020-29, an employer may amend its section 125 cafeteria plan to allow employees to take any of the following actions as a mid-year election made during calendar year 2020:

Employer-sponsored health coverage

  • Make a new election on a prospective basis, if the employee initially declined to elect employer-sponsored health coverage
  • Revoke an existing election 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 on a prospective basis, provided that the employee attests in writing that the employee is enrolled, or will immediately enroll, in other health coverage not sponsored by the employer

Health FSAs

  • Revoke an election
  • Make a new election
  • Decrease or increase an existing election on a prospective basis

Dependent care assistance program

  • Revoke an election
  • Make a new election
  • Decrease or increase an existing election on a prospective basis

Keep in mind that the amendment to make mid-year election changes is effective only to changes made during 2020 as a temporary means for employees to adjust their coverage for their personal needs. However, there is no requirement in Notice 2020-29 that an individual must be adversely affected by COVID-19 to be eligible for an election change.

Also of note: Section 3702 of the CARES Act, which became effective on March 27, 2020, expanded health FSAs to include over-the-counter medications.

Extended claims period

An employer may amend its section 125 cafeteria plan to permit employees to apply unused amounts remaining in a health FSA or dependent care assistance program at the end of the grace period or end of the plan year 2020 to pay or reimburse medical or dependent care expenses incurred through December 31, 2020.

The extended claims period may prove particularly helpful to employees who postponed elective medical, dental or vision procedures in 2020, as a result of the pandemic.

Retroactive relief for high deductible health plans (HDHPs)

Employers may retroactively apply the previously announced temporary relief for HDHPS (Notice 2020-15) to January 1, 2020. (Earlier IRS guidance allowed HDHPS to cover expenses related to COVID-19 and furnished a temporary exemption for telehealth services).


 

 
 
 

Notice 2020-33

 

Increased carryover cap

The IRS increased the maximum amount of unused funds that health FSA participants can carry over without penalty at the end of the plan year. Effectively, the carryover amount accounts for inflation by making the carryover cap 20% of the maximum deferral amount (which is $2,750 for plan year 2020).

As a result, the maximum unused amount from a plan year starting in 2020 allowed to carry over to the immediately following plan year beginning in 2021 is $550, an increase from the previous limit of $500. (Carryover amounts from plan year 2019 to 2020 remain unchanged at $500.)

The maximum carryover amount ($500 for 2019 and $550 for 2020, as noted above) does not count against the annual health FSA salary deferral limit ($2,700 for 2019 and $2,750 for 2020). Furthermore, carryover amounts can be used to pay or reimburse a participant for medical care expenses incurred during the following plan year. For example, amounts deferred under a health FSA in 2020 can be carried over to pay expenses in 2021.

Individual coverage health reimbursement arrangements (HRAs)

Notice 2020-33 clarifies that a health plan can reimburse individual insurance policy premiums incurred before the beginning of the plan year for coverage provided during the plan year (which will help implement individual coverage HRAs).


 

 
 
 

As an employer, what should I do?

 

1. Determine which provisions of Notices 2020-29 and 2020-33 you will allow.

2. Contact your section 125 cafeteria plan administrator to coordinate:

  • The process to handle the increased volume of mid-year employee election changes.
  • The impact of the retroactive adoption date on previously forfeited amounts and employee contributions that need to be refunded.
  • The process to alert employees of the plan changes and their ability to make mid-year election changes.

3. Notify employees of the specific elections they can change and how to do so, as well as whether they will have additional time to use their plan balances at year end.

4. Execute the written plan amendment by December 31, 2021.


 

 
 
 

How can Yoder & Co. CPA help?

 

The Yoder team can work with you to discuss and assess how these health care plan changes may affect your tax situation. Be sure to contact your Yoder & Co. accountant on how to optimize your tax strategies for the continued changes as a result of the COVID-19 pandemic.