Use It, but Don’t Lose It: New Stimulus Law Extends Time to Spend Down 2020 Health FSA and Dependent Care Balances

Employers will now have additional options to address participants’ unspent contributions to dependent care or health flexible spending accounts (FSAs) resulting from the COVID-19 pandemic. The Consolidated Appropriations Act, 2021 (H.R. 133, P.L. 116-260), signed into law on December 27, 2020, provides temporary relief for employees that were unable to spend down their dependent care and health FSAs by the end of the plan year and may otherwise forfeit these contributions.

The latest federal COVID-19 relief measures included in the Consolidated Appropriations Act (CAA) provides some good news for employees who participated in their employers’ health care and dependent care flexible spending arrangements (FSAs) during 2020 and feared losing their unused contributions.

Health care and dependent care FSAs are employer-sponsored benefits, which permit employees to set aside money on a pre-tax basis for the payment or reimbursement of eligible medical or dependent care expenses, as applicable. Both health care and dependent care FSAs are subject to strict election change rules governed by the Internal Revenue Code (IRC) and U.S. Department of the Treasury regulations that limit the circumstances under which an employee may change his or her election once it has been made for a plan year. Unused FSA funds at the end of the plan year are forfeited, subject to narrow exceptions.

During 2020, due to the COVID-19 pandemic, many employees found that they were unable to spend dependent care or health FSA funds because dependent care facilities were closed or they were unable to obtain certain medical or dental care for which they had planned to use their health FSA funds. As a result, many employees did not incur the medical or dependent care expenses that they had anticipated during 2020, resulting in their health care or dependent care FSA funds going unused. Without relief from Congress or the Internal Revenue Service (IRS), those unused funds would generally have been forfeited by employees. In May 2020, the IRS issued Notice 2020-29, allowing for some midyear election changes, but for many FSA participants, more relief was needed.

Fortunately, Congress has now stepped in, offering various relief options for health and dependent care FSA participants to prevent them from forfeiting their FSA funds.

Unused contributions may be carried forward into 2021 or 2022

If permitted by plan amendments, participants with unused FSA funds at the end of the 2020 plan year may carry all of those funds over for use during the 2021 plan year. Likewise, if permitted by the plan, participants with unused FSA funds remaining at the end of the 2021 plan year may carry those funds over for use in the 2022 plan year.

“Grace periods” may be extended to 12 months

Under prior law, an FSA could be designed to include a “grace period,” which is a period of up to two-and-a-half months immediately following the end of the plan year, during which employees could continue to incur health care or dependent care expenses that could be paid or reimbursed with the prior plan year’s funds. The new relief permits plans to extend a grace period for up to 12 months after the plan year ends, during which employees may incur expenses that may be paid or reimbursed from the prior plan year’s funds.

Under prior law, plans could either have a carryover feature described above (limited to $500), or a grace period, but not both. Presumably, the same is true under the new relief: a plan may implement an unlimited carryover or an extended grace period, but not both.

Post-termination reimbursement

An employee who ceases to participate in a health FSA during calendar year 2020 or 2021 may continue to receive reimbursements from unused contributions to his or her health FSA (but not from a dependent care FSA) for the remainder of the plan year during which participation ended, including any grace period allowed under the plan. Prior to this new relief, coverage could only be extended under a health FSA following a termination of participation by continuing coverage under the Consolidated Omnibus Budget Reconciliation Act (COBRA) of 1985.

Increased dependent age limit for dependents who “age out” during pandemic

Under prior law, dependent care FSAs could only reimburse expenses for the care of dependents who had not yet reached the age of 13.

Under the new relief, if an employee enrolled in a dependent care FSA for the last plan year in which the annual enrollment period occurred on or before January 31, 2020 (for calendar-year plans, this means the 2020 plan year), the employee had one or more dependents who turned 13 years old during that 2020 plan year, and the employee had funds remaining in his or her dependent care FSA for the 2020 plan year, the limiting age for the child is raised to age 14 for the 2020 plan year. The limiting age remains at 14 for the 2021 plan year, but only with respect to any dependent care FSA funds that remained unspent at the end of the 2020 plan year.

This limited carryover of unspent funds does not require adoption by the plan of a carryover, as discussed above.

Midyear changes in election amounts

For a plan year that ends in 2021, an employee may be permitted to change his or her health or dependent care FSA elections on a prospective basis, even if the employee has not experienced a “change in status” event, as long as the employee’s new election does not exceed the annual dollar limit on employee contributions. As previously mentioned, this option was already in place for 2020 due to IRS Notice 2020-29. The CAA does not specify, however (as was the case under Notice 2020-29), so presumably an employee cannot modify his or her election to an amount that is less than the amount he or she had already been reimbursed for the year.

It is anticipated that the IRS will issue guidance with greater detail as to how the above provisions are to be applied.

Employers may begin operating in accordance with this relief now, but plans must be formally amended to incorporate the relief provisions no later than the first day of the calendar year after the end of the plan year in which the provisions became effective. That means, for example, for a plan using the calendar year as the plan year, for changes implemented in 2020, a plan amendment must be adopted no later than December 31, 2021.

Ogletree Deakins will continue to monitor and report on developments with respect to the COVID-19 pandemic and will post updates in the firm’s Coronavirus (COVID-19) Resource Center as additional information becomes available. Important information for employers is also available via the firm’s webinar and podcast programs.