The Taxpayer Certainty and Disaster Relief Act of 2020 (the act) included in the Consolidated Appropriations Act, 2021, which was enacted on Dec. 27, 2020, includes temporary relief in connection with health and dependent care flexible spending arrangements (FSAs) under cafeteria plans. The U.S. Department of the Treasury and the IRS recently released Notice 2021-15 to provide much needed guidance on the act’s temporary relief.
Section 125 cafeteria plans and FSAs
Generally, an IRC Section 125 cafeteria plan must satisfy numerous requirements. Among these are that the plan must be in writing, be limited to employees, satisfy nondiscrimination requirements, and permit participants to choose among two or more benefits consisting of cash and “qualified benefits” (certain benefits that otherwise are not includible in an employee’s wages under another tax code provision). Qualified benefits include (but aren’t limited to) FSAs for qualified medical expenses (health FSAs) and FSAs under an IRC Section 129 dependent care assistance program (dependent care FSA).
Generally, the employee must elect before the first day of a plan year to reduce salary so that dollars can be available for reimbursement of qualified benefit expenses incurred during the plan year. The election to reduce salary is irrevocable unless the plan includes the ability to revoke or change the election for permitted midyear changes.
The annual limit on an employee’s salary reduction for a health FSA is $2,750 (for 2020 and 2021). This limit is $5,000 (for 2020 and 2021) for a dependent care FSA. If applicable rules are satisfied for the qualified benefit and the cafeteria plan, both the salary reductions and reimbursements are not taxable wages to the employee.
For both a health FSA and a dependent care FSA, the general cafeteria plan rules require the employee to forfeit amounts remaining in the FSA at the end of a plan year (the “use-it-or-lose-it” rule). However, a plan may permit a grace period of up to 2 1/2 months immediately after the end of the plan year for employees to use those amounts.
For a health FSA, instead of a grace period, an employer may instead allow a limited amount of unused funds in a plan year to be carried forward to the next plan year (the “carryover” rule), but these carryover amounts must be forfeited if not used by the end of the subsequent plan year. The carryover limit for 2020 was $500 in 2020 and is $550 in 2021.
Last year, among other relief, Treasury and the IRS extended the period during which employees could apply unused health FSA amounts and dependent care FSA remaining as of the end of a grace period or plan year ending in 2020 to pay or reimburse medical care expenses or dependent care expenses incurred through Dec. 31, 2020.