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On February 18, 2021, the Treasury Department and Internal Revenue Service (IRS) issued much anticipated guidance (<a href="https://www.irs.gov/pub/irs-drop/n-21-15.pdf" target="_blank" rel="noopener">IRS Notice 2021-15</a>) related to the flexible spending account (FSA) forfeiture relief enacted late last year under the Consolidated Appropriations Act, 2021, Pub.&nbsp;L. 116-260, 134 Stat. 1182 (Dec. 27, 2020) (CAA).

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Continuing the trend of prior FSA relief related to COVID-19, the CAA includes a number of provisions that temporarily relax flexible spending account rules to allow plan sponsors to mitigate participant losses under health care and dependent care FSAs.

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That relief, explained in greater detail below, includes the following temporary relief:

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Notably, the relief does not allow participants to receive refunds of any unused contributions at any time.

The recent IRS guidance answers key questions about the parameters of that relief and provides the following additional relief:

The relief is permissive, not required. Plan sponsors can choose to adopt any portion or none of the relief.

The table below shows the key differences (and in some cases, similarities) between the standard cafeteria plan rules and the above-described relief.

Standard Cafeteria Plan Rules

Carryover for health care FSAs is subject to a maximum cap ($550 for carryover from the 2020 to the 2021 plan year).

Plan sponsors can allow carryover of up to the full balance remaining in a participant’s health care FSA account from the 2020 plan year to the 2021 plan year and from the 2021 plan year to the 2022 plan year.

Carryover is not permitted for dependent care FSAs.

The unlimited carryover relief can be applied to dependent care FSAs.

Cannot be combined with a grace period plan design.

The relief can be adopted for FSAs that currently include a standard grace period or carryover or by plans that currently do not provide for carryover or a grace period.

Plan sponsors implementing a standard health care FSA carryover feature can require participants to elect to enroll in the FSA with a minimum contribution in order to get access to carried over amounts from the prior year.

Plan sponsors can apply the same requirement to health care and dependent care FSAs when adopting the carryover relief.

Health care FSA amounts may be used only for qualified medical care expenses, and dependent care FSA amounts may be used only for qualified dependent care expenses.

The same rule applies to the relief. A plan sponsor cannot transfer or carry over funds from a dependent care FSA to a health care FSA or vice versa.

Amounts carried over from a prior year do not impact contribution limits for the current year.

Grace period cannot extend beyond the 15th day of the third month immediately following the end of the plan year (i.e., March 15 for a calendar year plan).

Grace periods for plan years ending in 2020 and 2021 can be extended up to 12 months after the plan year (i.e., for a 2020 calendar year FSA, a plan sponsor can adopt this relief to give participants up to December 31, 2021 to incur claims for reimbursement from their 2020 FSA funds).

Cannot be combined with a carryover feature.

Amounts available for use during the grace period do not impact contribution limits for the current year.

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The following Q&amp;As address some of the questions answered by the IRS with respect to the implementation of this relief.

Q. How can plan sponsors adopt this relief?

A. To adopt this relief, the employer or plan sponsor must adopt a plan amendment and notify all employees eligible to participate in the plan of the plan changes.

In general, if adopting the relief described above:

Examples of the amendment deadlines as applied to a calendar year plan are shown below.

Relief

Amendment Deadline (for Calendar Year Plan)

Adopt unlimited carryover or extended grace period for the 2020 plan year

December 31, 2021

Adopt unlimited carryover or extended grace period for the 2021 plan year

December 31, 2022

Adopt mid-year election relief for the 2021 plan year

Q. What’s the difference between the unlimited carryover and extended grace period designs? Don’t they both allow participants to spend down unused amounts from one year’s account during the following year?

A. Functionally, those options are similar. However, there are some important differences.

First, the unlimited carryover and extended grace period options interact differently with the post-termination health care FSA relief. As shown in the examples below, the grace period relief provides an extra year for terminated participants to spend down their accounts.

Example 1 – Post-Termination Relief and Unlimited Carryover

Company A sponsors a calendar-year health care FSA that normally does not provide for carryover or a grace period. For the 2021 plan year, Company A adopts the post-termination relief (limited to actual unused contributions) and the unlimited carryover relief (meaning participants will be permitted to carry over their full unused balance from 2021 to 2022). Bob terminates participation in the health care FSA effective August 31, 2021, with $1,000 remaining in unused contributions. Bob has until December 31, 2021 to spend down those unused amounts. If Bob incurs less than $1,000 in eligible expenses by that deadline, the unused amounts will be forfeited.

Example 2 – Post-Termination Relief and Extended Grace Period

Company B sponsors a calendar-year health care FSA that normally does not provide for carryover or a grace period. For the 2021 plan year, Company B adopts the post-termination relief (limited to actual unused contributions) and the maximum extended grace period relief (meaning participants will be permitted to continue to incur claims for reimbursement from their 2021 health care FSAs through December 31, 2022). Bob terminates participation in the health care FSA effective August 31, 2021, with $1,000 remaining in unused contributions. Bob will have the remainder of 2021 and the associated 12-month extended grace period (i.e., until December 31, 2022) to spend down those unused amounts. Accordingly, in this example, Bob has a full 16 months to spend his unused funds, versus four months in Example 1.

Second, the carryover design allows unused funds to continue to be carried over from year to year (i) on an unlimited basis from 2020 to 2021 and from 2021 to 2022 and (ii) subject to the standard cap, for future years for health care FSAs. By contrast, the extended grace period allows continued use of the funds only during the extended grace period.

Example 1 – Unlimited Carryover

Company A sponsors a calendar-year health care FSA and adopts the unlimited carryover relief (meaning participants will be permitted to carry over their full unused balance from 2020 to 2021 and from 2021 to 2022).

Example 2 – Extended Grace Period

Company B sponsors a calendar-year health care FSA and adopts the extended grace period relief (meaning participants will be permitted to continue to incur claims for reimbursement from their 2020 health care FSAs through December 31, 2021 and for their 2021 health care FSAs through December 31, 2022).

Q. How does this relief impact HSA compatibility?

A. Although this relief does not change the general rule that an individual participating in a general purpose health care FSA is not eligible to contribute to an HSA, it provides new options to help participants avoid such ineligibility.

Participants will be HSA-ineligible during periods when:

The IRS has provided several options for preserving HSA eligibility. Specifically:

Q. Can plan sponsors adopting the mid-year election relief apply limits to that relief?

A. Yes. Similar to last year, plan sponsors have broad flexibility to set their own limits to the mid-year election relief. For example, a plan sponsor may choose to limit the time period during which participants can exercise that relief (e.g., by implementing a specific election-change window). A plan sponsor also may limit types of election changes permitted (e.g., by allowing participants to decrease health care FSA elections only to the greater of the amount they’ve already contributed or the amount they’ve received in reimbursements for the plan year).

Q. We’ve decided to adopt the post-termination health care FSA relief and allow terminating participants to continue to use the amounts they’ve already contributed to their health care FSAs (not their full elected amounts) through the end of the plan year. Do we still have to offer COBRA?

A. Yes. A participant who terminates employment or loses eligibility due to a reduction in hours must be offered COBRA in these circumstances. That participant must be given the choice between (i) continuing access to unused contributions or (ii) electing COBRA to continue access to the full election amount (minus reimbursements made to date).

Q. If we adopt either the unlimited carryover or extended grace period for our dependent care FSA, will this impact the amount we are required to report for dependent care contributions in Box 10 of employees’ Forms W-2?

A. No. Consistent with previous reporting guidance, employers may report the salary reduction amount elected by the employee for the year (plus any employer matching contributions). Employers are not required to include amounts that remain available in a grace period associated with the prior year or amounts that are carried over from a prior year.

Q. If we adopt the extended grace period or unlimited carryover relief, will that impact nondiscrimination testing for 2021 or 2022?

A. No. The IRS clarified in Notice 2021-15 that plans do not need to take into account amounts carried over or made available during an extended grace period for purposes of cafeteria plan and dependent care assistance program nondiscrimination testing.

Julia Ann Love 216.566.5686 <a href="mailto:Julia.Love@ThompsonHine.com">Julia.Love@ThompsonHine.com</a>

Dominic DeMatties 202.973.2744 <a href="mailto:Dominic.DeMatties@ThompsonHine.com">Dominic.DeMatties@ThompsonHine.com</a>

Kim Wilcoxon 513.352.6524 <a href="mailto:kim.wilcoxon@thompsonhine.com">Kim.Wilcoxon@ThompsonHine.com</a>

Beth A. Mandel 513.352.6695 <a href="mailto:beth.mandel@thompsonhine.com">Beth.Mandel@ThompsonHine.com</a>

or any member of our <a href="https://www.thompsonhine.com/services/employee-benefits-amp-executive-compensation">Employee Benefits &amp; Executive Compensation</a> group.

We have assembled a firmwide multidisciplinary task force to address clients’ business and legal needs related to the COVID-19 pandemic. Please see our <a href="https://www.thompsonhine.com/services/covid-19-task-force">COVID-19 Task Force</a> page for additional information and resources.

This advisory bulletin may be reproduced, in whole or in part, with the prior permission of Thompson Hine LLP and acknowledgment of its source and copyright. This publication is intended to inform clients about legal matters of current interest. It is not intended as legal advice. Readers should not act upon the information contained in it without professional counsel.

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IRS Issues Guidance on Consolidated Appropriations Act FSA Forfeiture Relief

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