IRS Provides Relief Through Increased Flexibility for Taxpayers in Cafeteria Plans

(Parker Tax Publishing May 2020)

The IRS issued guidance which provides for increased flexibility with respect to mid-year elections under a Code Sec. 125 cafeteria plan during calendar year 2020 related to employer-sponsored health coverage, health flexible spending arrangements (health FSAs), and dependent care assistance programs. This guidance also provides increased flexibility with respect to grace periods to apply unused amounts in health FSAs to medical care expenses incurred through December 31, 2020, and unused amounts in dependent care assistance programs to dependent care expenses incurred through December 31, 2020. Notice 2020-29.

Background

Under Code Sec. 125(d)(1), a cafeteria plan is a written plan maintained by an employer under which all participants are employees, and all participants may choose among two or more benefits consisting of cash and qualified benefits. Elections regarding qualified benefits under a Code Sec. 125 cafeteria plan generally must be irrevocable and must be made before the first day of the plan year, except as provided under Reg. Sec. 1.125-4, which provides that a Code Sec. 125 cafeteria plan may permit an employee to revoke an election during a period of coverage and to make a new election under certain circumstances, such as if the employee experiences a change in status or there are significant changes in the cost of coverage. Code Sec. 125 does not require a cafeteria plan to permit the mid-year election changes allowed under Reg. Sec. 1.125-4.

Due to the nature of the public health emergency posed by COVID-19 and unanticipated changes in the need for medical care, the IRS said that some employers have indicated a willingness to offer employees who initially declined to elect employer-sponsored health coverage an opportunity to elect health coverage or allow employees enrolled in employer-sponsored health coverage to enroll in different health coverage offered by the same employer or drop their existing employer-sponsored health coverage to enroll in other health coverage not offered by their employer (for example, coverage offered by their spouse's employer). In addition, some employees may have an increase or decrease in medical expenses due to unanticipated changes in the need for or availability of medical care and may wish to increase or decrease amounts in their health flexible spending arrangements (FSAs). Further, some employees may have an increase or decrease in the need for dependent care assistance due to the unanticipated closure of schools and child care providers and changes to the employee's work location or schedule.

In response, the IRS issued Notice 2020-29, in which it provides for increased flexibility with respect to mid-year elections under a Code Sec. 125 cafeteria plan during calendar year 2020 related to employer-sponsored health coverage, health FSAs, and dependent care assistance programs. The notice also provides increased flexibility with respect to grace periods to apply unused amounts in health FSAs to medical care expenses incurred through December 31, 2020, and unused amounts in dependent care assistance programs to dependent care expenses incurred through December 31, 2020.

Notice 2020-29 Relief

For mid-year elections made during calendar year 2020, Notice 2020-29 provides that a Code Sec. 125 cafeteria plan may permit employees who are eligible to make salary reduction contributions under the plan to:

(1) with respect to employer-sponsored health coverage, (i) make a new election on a prospective basis, if the employee initially declined to elect employer-sponsored health coverage; (ii) revoke an existing election and make a new election to enroll in different health coverage sponsored by the same employer on a prospective basis; and (iii) revoke an existing election on a prospective basis, provided that the employee attests in writing that the employee is enrolled, or immediately will enroll, in other health coverage not sponsored by the employer;

(2) revoke an election, make a new election, or decrease or increase an existing election applicable to a health FSA on a prospective basis; and

(3) revoke an election, make a new election, or decrease or increase an existing election regarding a dependent care assistance program on a prospective basis.

For unused amounts remaining in a health FSA or a dependent care assistance program under the Code Sec. 125 cafeteria plan as of the end of a grace period or plan year ending in 2020, Notice 2020-29 provides that a Code Sec. 125 cafeteria plan may permit employees to apply those unused amounts to pay or reimburse medical care expenses or dependent care expenses, respectively, incurred through December 31, 2020.

In addition, Notice 2020-29 provides that the relief provided in Notice 2020-15 regarding high deductible health plans, and expenses related to COVID-19, and in Section 3701 of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) regarding an exemption for telehealth services, may be applied retroactively to January 1, 2020.

For a discussion of the rules for making Code Sec. 125 cafeteria plan elections, see Parker Tax ¶122,535. For a discussion of the rules relating to health FSAs and dependent care assistance programs, see Parker Tax ¶122,555 and ¶120,500, respectively.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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