IRS Increases Health FSA Carryforward Limit and Cafeteria Plan Flexibility

In response to the changes caused by COVID-19, the IRS has provided additional flexibility for health flexible spending accounts (FSA’s), dependent care assistance programs, and employer health plans. Many employees take advantage of these programs (collectively known as “cafeteria plans”) to set aside pre-tax money for medical and dependent care expenses. However, decisions regarding these programs must generally be made at the beginning of a plan year and cannot be revoked later, unless certain events occur. Additionally, amounts left in health FSA’s or dependent care assistance accounts at year-end are generally lost, unless a plan provides for a limited grace period or allows the carryover of a limited dollar amount. In light of the fact that health and dependent care expenses may have fluctuated this year for many individuals, the IRS is allowing more flexibility for participants in the arrangements.

In general, employers may choose the extent to which they will allow their employees to take advantage of the changes. An employer chooses which changes (if any) to implement by adopting a plan amendment. Additionally, all eligible employees must be notified of the changes made to the plan.

Here are some of the changes, released in recent IRS Notices:

  • Increased health FSA carryover limit to the following year from a fixed $500 to 20% of the maximum contribution amount. This would equal up to $550 able to be carried forward to 2021 (since the maximum FSA contribution for 2020 is $2,750). After 2020, this limit will be indexed for inflation and may be increased in multiples of $10.
  • Until the end of 2020, employers may allow employees to make changes to their health FSA’s, including an initial election to contribute to such an account. Although these changes can only affect future salary received, FSA amounts may be used to cover any qualifying expenses from the beginning of a plan year beginning on or after January 1, 2020. Other items which may also be modified during the 2020 plan year include employer-paid health insurance and dependent care assistance. All the above items may be initiated, revoked, or adjusted on a prospective basis. Note that an employee may only revoke the health insurance if the employee attests that they will immediately enroll in other comprehensive coverage.
  • Employers may also amend their cafeteria plans to provide more flexibility relating to grace periods for medical or dependent care amounts incurred during 2020.

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