In CAA-21 Guidance, IRS Addresses Health FSA and DCAP Carryovers, Extended Claims Periods, COBRA Interactions, and More

Practical Law Legal Update w-029-7541 (Approx. 8 pages)

In CAA-21 Guidance, IRS Addresses Health FSA and DCAP Carryovers, Extended Claims Periods, COBRA Interactions, and More

by Practical Law Employee Benefits & Executive Compensation

CAA-21 Provisions Involving Health FSAs and DCAPs Under Cafeteria Plans

The CAA-21 includes several provisions relating to cafeteria plans, health FSAs, and DCAPs, which are addressed in the IRS's guidance. In particular, the CAA-21:

Offers relief regarding carryovers of unused amounts in the 2020 and 2021 plan years.
Extends the period for incurring claims for plan years ending in 2020 and 2021.
Provides a rule governing post-termination reimbursements from health FSAs for the 2020 and 2021 plan years.
Includes a claims period and carryover rule for DCAPs if a dependent "ages out" during the COVID-19 public health emergency.
Permits specified health FSA and DCAP mid-year election changes for plan years ending in 2021.

The guidance also permits eligible employees to make certain cafeteria plan election changes—for plan years ending in 2021—concerning employer health coverage (see CAA-21-Related Cafeteria Plan Election Changes).

Health FSA and DCAP "Section 214 Carryovers" Under the CAA-21

Notice 2021-15 implements a CAA-21 requirement under which, for plan years ending in 2020, a cafeteria plan with a health FSA or DCAP that is timely amended can permit participants to carry over (under rules similar to existing health FSA rules) unused benefits or contributions from that plan year to the plan year ending in 2021. A related rule for plan years ending in 2021 permits carryovers of unused benefits or contributions into plan years ending in 2022. Collectively, these carryovers are referred to as "Section 214 carryovers" (named for the section number of the CAA-21 containing these changes). Importantly, health FSA amounts must only be used for medical care expenses and DCAP amounts must only be used for dependent care expenses.

Under the IRS's guidance:

A cafeteria plan can be amended to permit Section 214 carryovers regardless of whether it currently has a grace period or provides for carryovers (see also Legal Update, In Change to "Use-or-Lose" Rule, IRS Permits $500 Carryover of Health FSA Balances).
Employers may limit Section 214 carryovers to:
- an amount less than all unused amounts; and
- apply only up to a specified date during the plan year.
All amounts available as of the last day of the 2020 or 2021 plan year may be carried over, regardless of the source of the amounts.

The IRS's guidance addresses the effect of Section 214 carryovers and individuals' eligibility to contribute to health savings accounts (HSAs) (see Practice Note, Defined Contribution Health Plans: Overview: Health Savings Accounts (HSAs)). In general, an individual cannot make HSA contributions during a month in which the individual participates in a general-purpose health FSA to which unused amounts are carried over under the CAA-21.

Extended Health FSA and DCAP Claims Periods

Under the CAA-21, cafeteria plans with a health FSA or DCAP may extend their grace periods—for plan years ending in 2020 or 2021—to 12 months after the end of the plan year, regarding unused benefits or contributions remaining in a health FSA or DCAP. As a result, for example, an employer that had a cafeteria with a health FSA in 2020 could amend the plan to let employees apply their entire unused amounts as of December 31, 2020 to reimburse medical care expenses (but not DCAP expenses) incurred through December 31, 2021.

Under the IRS's guidance, an extended grace period for incurring claims:

May be less than 12 months in duration.
May end before the end of the plan year.
Is available regardless of whether an employer's cafeteria plan currently has a grace period or provides for carryovers.

Also, an individual who participates in a general-purpose health FSA is ineligible to make HSA contributions—and this includes during extended claims periods under the CAA-21. However, employers may include an employee opt-out regarding any extended period for incurring claims ending in 2021 and 2022 (for employees who wish to preserve HSA eligibility).

Impact on 2023 Plan Years

If a cafeteria plan includes a CAA-21 grace period for the plan year ending in 2022, that period will allow employees to use all amounts remaining at the end of the 2022 plan year for expenses during the first two-and-a-half months during the plan year ending in 2023 (see Practice Note, Cafeteria Plans: Grace Period Exception to Use-or-Lose Rule). Relatedly, for a cafeteria plan with a CAA-21 carryover for the plan year ending in 2022, that carryover would permit employees to use up to $550 (or, if greater, 20% of the contribution limit) of unused amounts remaining at the end of the 2022 plan year for expenses incurred during any month of the plan year ending in 2023 (26 U.S.C. § 125(i)).

Post-Termination Health FSA Reimbursements

Also under the CAA-21, a cafeteria plan with a health FSA may permit an employee who stops participating in the plan during the 2020 or 2021 calendar years to receive reimbursements from unused benefits through the end of the plan year in which participation ended (and including grace periods). The IRS's guidance permits employers to limit the amount of unused amounts in a health FSA to salary reduction contributions an employee has made:

From the beginning of the plan year in which the employee stops being a participant.
To the date the employee is no longer a participant.

This option is permitted regarding employees who stop being participants due to:

Employment terminations.
Changes in employment status.
New elections during the 2020 or 2021 calendar years.

Notice 2021-15 clarifies that an employer may not amend its cafeteria plan to adopt both the Section 214 carryover and the extended grace period under the CAA-21 for a plan year for a particular health FSA or DCAP. Rather, the amendment must specify which option is adopted for applicable plan years.

Amounts that are carried over or available during an extended claims period are not considered regarding cafeteria plan or DCAP nondiscrimination requirements (see Practice Note, Cafeteria Plans: Nondiscrimination Requirements).

CAA-21-Related Cafeteria Plan Election Changes

Under the CAA-21, cafeteria plans may permit employees to make mid-year health FSA and DCAP election changes (prospectively) for plan years ending in 2021, without regard to changes in status (see Practice Note, Cafeteria Plans: Changes in Status and Cafeteria Plan Election Changes). The statute generally permits an employer to amend its cafeteria plans to allow health FSA or DCAP participants to prospectively revoke an election, make one or more elections, or increase or decrease an existing election for plan years ending in 2021. These election changes include prospectively making an initial election to enroll in a health FSA or DCAP for the year. For example, this would allow an employee who initially declined to enroll in a health FSA or DCAP to make an election change to use a Section 214 carryover or extended claims period.

Under Notice 2021-15, an employee also can:

Make a new prospective election for employer-sponsored health coverage (whether insured or self-funded), where the employee initially did not elect that coverage.
Revoke a current election for an employer's coverage, and prospectively make a new election to enroll in different health coverage offered by the same employer. (This may include changing from self-only to family coverage.)
Prospectively revoke a current election for an employer's coverage, if the employee attests that the employee intends to immediately enroll in other coverage not sponsored by the employer.

These rules are similar to IRS mid-year election change relief provided during 2020 (under Notice 2020-29) for calendar years ending in 2020 (see Article, Cafeteria Plan Election Changes and COVID-19). Regarding the third of the above options, the IRS's guidance includes requirements involving employee attestations and model written attestation language.

An employer that adopts the permitted election changes under the CAA-21 or the IRS's guidance:

Need not make available unlimited election changes, but may determine the scope of changes permitted within the above parameters.
Can consider the potential for adverse selection in health coverage by employees (and therefore only permit changes where an employee's coverage is improved or increased).

As to health FSAs and DCAPs, an employer may restrict mid-year election changes to:

Amounts that are not less than the amounts already reimbursed.
Certain kinds of mid-year election changes (for example, only decreases in elections).

In addition, employers may:

Allow mid-year election changes without a status change up to a certain date during the plan year, but require a status change after that date—for example, by requiring:
- no status change if an election is changed before March 31, 2021; but
- a status change for an election to be changed after that date.
Limit the number of election changes during the plan year that are not associated with a status change (for example, permitting one election change in the 2021 plan year without a status change).

The IRS's guidance also addresses the treatment of amounts previously contributed (on a pre-tax basis) to fund a health FSA or DCAP if an employee's election is revoked. In this situation, for example, a cafeteria plan could provide that amounts contributed before revocation are either:

Available only to reimburse eligible expenses incurred before the revocation takes effect (but not later-incurred expenses).
Forfeited.

Additional rules in the IRS's guidance address revocations of health FSA elections and HSA eligibility.

Applicability of Annual Limits

For employers that adopt the CCA-21 carryover or extended period for incurring claims, the Code's health FSA and DCAP annual limits (under Code Sections 125(i) and 129(a), respectively):

Apply to amounts contributed to the health FSA or DCAP for a given year.
Do not apply to amounts reimbursed from the health FSA or DCAP for the year.

(26 U.S.C. §§ 125(i) and 129(a).)

As a result, unused amounts that are carried over from an earlier year (or available during an extended period for incurring claims) do not count against the annual limit for the next year.

COBRA Implications

Notice 2021-15 addresses how health plan continuation coverage requirements under COBRA interact with CAA-21 requirements involving health FSAs. (Regarding COBRA, see Practice Note, COBRA Overview and COBRA Toolkit.) For individuals who are otherwise COBRA qualified beneficiaries regarding health FSA coverage (for which COBRA rights may be available), a limited extension of coverage under the CAA-21's post-termination health FSA reimbursement rule does not prevent the individual from having a loss of coverage resulting in a COBRA qualifying event—for example, a termination of employment or reduction in hours (see Practice Note, COBRA Overview: Qualifying Events). As a result, an employer in this case must provide the individual a COBRA election notice (see Standard Document, COBRA Election Notice). The IRS's guidance includes the example of an employee who:

Elected to contribute $2,400 to a health FSA.
Terminated employment with the employer on January 31, after making $200 in salary reduction contributions.
Therefore could no longer contribute to the health FSA (aside from electing COBRA).

The employer in this example could allow the employee to either:

Request reimbursement for up to $200.
Elect COBRA (and have access to the $2,400) by paying COBRA premiums of $200/month on an after-tax basis.

Also, for employers that adopt a Section 214 carryover or extended period for incurring claims under the IRS's guidance, the maximum COBRA premium does not include unused amounts carried over or available during the extended period. As a result, the COBRA premium payable for providing access to the carryover amounts (or for the extended period) is zero (see Notice 2015-87 and Legal Update, IRS Guidance Addresses HRAs, COBRA, ACA Information Reporting and TRICARE: COBRA and Health FSA Carryovers).

Employers need not allow an individual who stops participating in a cafeteria plan to continue receiving reimbursements from unused health FSA amounts if the individual does not qualify for and elect COBRA.

Plan Amendments

Employers must adopt cafeteria plan amendments to take advantage of the CAA-21 relief provisions. Under the CAA-21, a cafeteria plan with a health FSA or DCAP can be amended (effective retroactively) for a CAA-21 provision if:

The amendment is adopted by the last day of the first calendar year beginning after the end of the plan year in which the amendment is effective.
The plan is operated consistent with the amendment's terms from the amendment's effective date until the amendment is adopted.

The employer also must inform all eligible employees of the changes to the cafeteria plan.

Practical Impact

The IRS's guidance offers several cafeteria plan design options for plan sponsors that should be popular with participants in employers' health FSAs and DCAPs. Because some of the options are alternatives to one another, employers also will need to decide which option is optimal, and timely adopt necessary plan amendments and participant communications.

In CAA-21 Guidance, IRS Addresses Health FSA and DCAP Carryovers, Extended Claims Periods, COBRA Interactions, and More | Practical Law