IRS Provides Guidance on Cafeteria Plan Balance Carryovers

Recent guidance from the IRS has provided greater flexibility to employee benefit plans that offer health flexible spending accounts (FSAs) or dependent care assistance programs.

Several provisions in the Consolidated Appropriations Act, 2020, which was enacted in late December of 2020, gave these plans additional discretion in 2021 and 2022 to adjust their programs to help employees better meet the unanticipated consequences of the public health emergency caused by COVID-19. The new law enables plan sponsors (employers) to provide flexibility to plan participants (employees) that can help them respond to unanticipated changes in the availability of certain medical care and dependent care.

Millions of employees have access to health FSAs and dependent care assistance programs, sponsored by employers under “cafeteria plans.” Generally, under these plans, an employer allows its employees to set aside a certain amount of pre-tax wages to pay for medical care and dependent care expenses. Amounts spent by the employee are then reimbursed from their designated health FSAs or dependent care assistance programs. 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. As a result of COVID-19, participating employees are more likely to have unused health FSA amounts or dependent care assistance program amounts at the end of the year. In accordance with the Taxpayer Certainty and Disaster Tax Relief Act of 2020, Notice 2021-15 gives employers the option to amend their plans to provide greater flexibility for employees to elect and use these programs during the pandemic without risking the forfeiture of the amounts they have set aside. The employer is allowed to permit employees to use funds for up to an additional 12 months after the end of the plan year for plan years ending in 2020 or 2021.

Notice 2021-15 outlines the administrative process by which plan sponsors can amend their plans to allow for carryover of unused amounts from the 2020 and 2021 plan years, among other things. The IRS guidance helps employers administer the new plan rules in the following areas:

• The carryover of unused amounts from the 2020 and 2021 plan years
• Extension of the permissible period for incurring claims for plan years ending in 2020 and 2021
• Adoption of a special rule regarding post-termination reimbursements from health FSAs
• Creation of a special claims period and carryover rule for dependent care assistance programs when a dependent “ages out” during the COVID-19 public health emergency
• Allowance of certain midyear election changes for health FSAs and dependent care assistance programs for plan years ending in 2021

Prior guidance provided flexibility to employers with cafeteria plans through the end of calendar year 2020, during which employers could permit employees to apply unused health FSA amounts and dependent care assistance program amounts to pay for or reimburse medical care or dependent care expenses incurred through December 31, 2020. The Taxpayer Certainty and Disaster Tax Relief Act of 2020, signed into law on December 27, 2020, provides similar flexibility for these arrangements in 2021 and 2022.

To learn more about how these rule changes could affect your cafeteria plans, please contact your CRI advisor.