In Notice 2020-29, the IRS allows employers to amend their IRC Section 125 cafeteria plans to make temporary changes for 2020 to give employees greater flexibility in arranging their benefits to pay for medical and childcare expenses.

The COVID-19 pandemic has given rise to circumstances whereby employees may wish to change health plan, health flexible spending arrangement (health FSA), or dependent care program elections that would not qualify under the normal mid-year election change rules. For example, employees may have put off elective medical procedures or experienced significant changes in childcare expenses due to school and childcare service closures. Absent relief, the ability to make such changes is significantly limited; for health FSAs and dependent care programs, amounts that remain unspent are forfeited.

Under Notice 2020-29, employers may amend cafeteria plans to allow employees to change their health care coverage and/or contributions to health FSAs and dependent care assistance programs during 2020. Notice 2020-29 also extends the time in which employees can spend unused amounts in their health FSAs or dependent care assistance programs.

Mid-year changes in health FSAs and dependent care program elections

To qualify as a cafeteria plan under IRC Section 125, an employer must offer plan participants the choice of two or more benefits consisting of cash and qualified benefits, which may include health benefits and dependent care benefits.

Cafeteria plan elections generally must be irrevocable and made before the first day of the plan year. Cafeteria plans may permit employees to revoke and make new elections during a period of coverage under certain circumstances, such as if the employee experiences a change in status or the cost of coverage changes significantly. Notice 2020-29 temporarily allows employers to amend their cafeteria plans to allow participants to make prospective election changes in 2020 for employer-sponsored health coverage, health FSAs or dependent care assistance programs under circumstances that do not meet the normal requirements for mid-year election changes.

Specifically, employers can amend their cafeteria plans to allow employees to prospectively do the following:

For employer-sponsored health coverage

• Make a new election (for employees who initially declined coverage)
• Revoke an existing election and elect to enroll in different health coverage from the same employer ,
  or
• Revoke an existing election, without enrolling in different coverage from the same employer, if the employee attests in writing that he or she will enroll in other health coverage

For health FSAs or dependent care assistance programs

• Revoke an election
• Make a new election
  or
• Decrease or increase the amount of an existing election

In "determining the extent to which election changes are permitted and applied," the IRS noted, "an employer may wish to consider the potential for adverse selection of health coverage by employees." For example, an employer may limit elections to circumstances in which the election will result in an employee's coverage being increased or improved.

Extended period to allow unused health FSA or dependent care assistance program amounts

Under IRC Section 125, health FSAs may either allow participants to (1) carry over a certain amount in their health FSAs at the end of the plan year to use toward medical expenses incurred in the following year or (2) use unused amounts during a grace period of up to two months and 15 days (March 15 in a calendar-year plan). Dependent care assistance programs may not permit carryover but may provide for a grace period.

Notice 2020-29 permits employers to amend their cafeteria plans to allow participants to apply the unused amounts that would have expired at the end of a plan year or grace period ending in 2020 to expenses incurred in 2020. The extension is available both for cafeteria plans that have a grace period and plans that have a carryover provision.

Notice 2020-33 increases the permissible carryover amount to $550 (from $500) for health FSAs with plan years beginning in 2020 and changes the rule from a specific dollar amount to 20% of the maximum salary reduction contribution that may be made to a health FSA under IRC Section 125(i) ($2,750 for 2020).

Relief for HDHPs

Under IRC Section 223, an eligible individual may make tax-favored contributions to a health savings account (HSA). Principally, to be an eligible individual in each month, the individual must be covered by a high-deductible health plan (HDHP) and may not have other coverage. An HDHP is a health plan that satisfies certain requirements for deductibles and out-of-pocket expenses. Amounts may be payable from the plan only after the covered individual's medical expenses exceed the minimum annual deductible.

Under Notice 2020-15, HDHPs may cover COVID-19 testing and treatment without requiring satisfaction of the minimum deductible (see Tax Alert 2020-0543). Notice 2020-29 clarifies that this relief applies to reimbursements of expenses incurred on or after January 1, 2020.

The CARES Act created temporary rules for HSAs to facilitate telehealth services and other remote care. Effective from March 27, 2020, an HDHP is not required to impose any deductible or require cost-sharing for telehealth services or other remote care. Additionally, coverage for telehealth services or remote care outside the HDHP is disregarded. Thus, neither first dollar of HDHP coverage nor other coverage for telehealth and other remote care services will disqualify the participant from contributing to an HSA. Notice 2020-29 clarifies that these CARES Act provisions apply to services provided on or after January 1, 2020, for plan years beginning on or before December 31, 2021.

Amendment deadlines

To make use of the relief, an employer must amend its cafeteria plan for the 2020 plan year on or before December 31, 2021. The amendments may be effective retroactively to January 1, 2020, if the plan is operated in accordance with Notices 2020-29 and 2020-33, and the employer informs employees eligible to participate in the cafeteria plan of the changes.

Implications

This relief will be welcome to employees and employers alike. Some employers have been asking the Treasury Department and the IRS for this relief, and the guidance emphasizes that employers are free to take advantage of it, or not, at their discretion. For the 2020 calendar year, an individual may contribute up to $2,750 to a health care FSA and $5,000 to a dependent care assistance program. This relief will allow employees with increased expenses to achieve greater tax savings. For employees with decreased expenses, the relief will reduce the likelihood that contributions to such arrangements will be forfeited.

The plan year for many health FSAs and dependent care assistance programs is defined as the calendar year. For calendar year plans that do not offer a grace period, the relief provided in Notice 2020-29 to extend the period to apply unused amounts may have no impact.

Notice 2020-29 includes a footnote reminding taxpayers that the election-timing rules for qualified transportation fringes under IRC Section 132(f) are not subject to the IRC Section 125 election timing rules; instead, under longstanding rules, employees generally may be allowed to change or revoke those elections any time before the beginning of a pay period. It would seem that no relief was provided for qualified transportation fringes because none was thought to be needed.

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