IRS Grants Breaks on FSAs and DCAPs
The IRS is providing some leeway to employee benefit plans offering health flexible spending accounts (FSAs) and dependent care assistance plans (DCAPs). Under the COVID-19-related Taxpayer Certainty and Disaster Tax Relief Act of 2020, these plans now have additional discretion in 2021 and 2022 to adjust their programs to help employees better meet the unanticipated consequences of the public health emergency.
Notice 2021-15 responds to unanticipated changes in the availability of certain types of medical care and dependent care, according to the IRS. As a result of COVID-19, participating employees are more likely to have unused health FSA or DCAP amounts at the end of 2020 and 2021. Generally, under these plans, an employer allows its employees to set aside a certain portion of pretax wages to pay for medical care and dependent care expenses. Amounts spent by the employee are then reimbursed from their designated health FSAs or DCAPs.
Note the following key provisions, wherein the IRS allows:
- Flexibility to carry over unused amounts from the 2020 and 2021 plan years.
- Flexibility to extend the permissible period for incurring claims for plan years ending in 2020 and 2021.
- Flexibility to adopt a special rule regarding post-termination reimbursements from health FSAs.
- Flexibility for a special claims period and carryover rule for DCAPs when a dependent "ages out" during the COVID-19 public health emergency.
- Permission for certain midyear election changes in health FSAs and DCAPs 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 and DCAP amounts to pay for or reimburse medical care or dependent care expenses. 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.
Millions of employees have access to health FSAs and DCAPs sponsored by employers under cafeteria plans, says the IRS. It also notes that the decision to adjust these employee benefit programs is at the discretion of the employer that sponsors the plan.
Funds that are properly spent are not subject to federal income tax. However, account funds that are not spent by the employee within the plan year, subject to limited grace periods or certain carryover amounts, are forfeited. 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.
If you have questions about the details of the new rules or best practices in employee benefits, give us a call.