All Bets Are Off: IRS Issues New Playbook for Section 125 Plans During Pandemic

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On May 12, the IRS released Notices 2020-29 and 2020-33, which collectively provide various forms of relief under the existing IRC Section 125/129 rules in light of the COVID-19 pandemic. We’re including below a summary of the highlights of this relief:

1. Increased Flexibility Regarding Mid-Year Election Changes. Notice 2020-29 temporarily relaxes some of the Section 125 limitations on mid-year election changes. The Notice makes clear that (a) employers would have to amend their plans to permit this flexibility, (b) such amendment would only be effective for prospective (not retroactive changes), (c) these relaxed rules would only apply during calendar year 2020, or if desired, such shorter specified period as the employer permits (presumably if the employer doesn’t want to recognize the changes through the end of 2020). The IRS guidance makes clear that the Notice only provides the outside parameters of permitted election changes - employers may adopt changes more narrowly within this frame work, considering factors such as the potential for adverse selection. For instance, the IRS notes that if desired, the employer could decide to permit only election changes that would result in improvements in coverage (e.g., moving from self-only to family coverage).

Of significance, the IRS notes that even though plans may be amended to permit prospective election changes only, to the extent employers were already permitting any of the sorts of changes described below, the plan can be amended retroactively to January 1, 2020 to ratify/legitimize those election changes if they otherwise would be in compliance with the Notice.

The newly recognized election changes for 2020 are the following:

a. Enroll in Coverage. Make a new election for employer-sponsored health coverage if the eligible employee previously declined.

b. Switch Plans or Tiers. Drop a current health coverage option to enroll in different coverage offered by the same employer (or to switch tiers -- e.g., single to family).

c. Drop Plan to Switch to Other Coverage. Drop health coverage under the employer-sponsored plan, but only upon certification that the employee will enroll in other health coverage (including individual coverage). The employer can rely on an attestation by the employee as to intent to enroll in other coverage as long as the employer doesn’t have reason to believe it is false.

d. FSA (Health and Dependent Care) Election Changes. Enroll in a flexible spending account (FSA), drop FSA coverage, or increase or decrease an existing FSA election. These changes apply to both health and dependent care FSA changes. The IRS notes that employers may limit coverage decreases to an amount no less than amounts already reimbursed by the plan, which is an important consideration for health FSAs under which an employee could already have spent down more than s/he contributed to date.

2. Extended Claims Period for FSAs. Notice 2020-29 provides that a plan may be amended for any plan year or grace period ending in 2020 to permit participants to “spend down” any remaining FSA amounts that would otherwise be forfeited through December 31, 2020. This extension of the spend-down deadline also applies to health FSAs that have a $500 carryover feature (meaning if the amounts over $500 would have been forfeited due to a plan year end date in 2020, that forfeiture need not occur before December 31, 2020). To be clear, this relief only appears to apply to plans with an off-calendar-year plan year, or calendar year plans that provide for a grace period (which has otherwise already expired). Calendar-year plans with no grace period do not appear to be able to take advantage of this relief.

Importantly, the IRS notes that this coverage extension could potentially constitute disqualifying coverage for persons enrolled in an HDHP. So, for instance, if a plan has a 7/1/19 - 6/30/20 plan year, and the plan is amended to permit unused general purpose FSA amounts to be spent down between 7/1/20 and 12/31/20, a person with an unused balance will not be eligible to contribute to an HSA during the 2020 calendar year (unless the employer modifies the design to make the spend-down amount HSA compatible with, or to forfeit the spend-down balance for persons enrolling in, an HDHP).

This relief applies for the entirety of the 2020 calendar year, but any elections made as a result of this guidance (which would presumably include an increase in an FSA election pursuant to item 1 above given the decreased risk of forfeiture, or something similar) may only be made on an prospective basis.

3. Amendment and Notice Requirements. Plans must be amended to adopt these forms of relief in the two items above, but any such amendment will be considered timely as long as it is made prior to December 31, 2021. Any timely-adopted amendment may be retroactive. Further, the IRS notice makes clear that to take advantage of this relief, plan sponsors must notify participants. (The Notice doesn’t specify the time or form of participant notification.)

4. HDHP/HSA Relief. Notice 2020-29 clarifies a few important points relating to HSA eligibility and COVID-related services:

a. Prior IRS guidance permitted plans to cover any COVID-related services at no cost without impacting HSA eligibility. This Notices clarifies that the guidance was applicable on a retroactive basis to January 1, 2020. The Notice further clarifies that coverage for any COVID testing or supply services required to be covered at no-cost under the FFCRA/CARES Act will not impact HSA eligibility.

b. The CARES Act permitted plans to provide free telehealth services (whether COVID-related or not) without impacting HSA eligibility (through 12/31/2020). Even though the CARES Act was not passed until March 27, 2020, the Notice clarifies that this relief will be applied retroactively to January 1, 2020 (in essence retroactively blessing any actions taken by plan sponsors to make telehealth free prior to the passage of the CARES Act).

5. Increase on Health FSA Carryovers. IRS guidance issued post-Affordable Care Act permitted Section 125 plans to adopt a carryover provision allowing up to $500 of unused amounts to carry forward for use in a subsequent plan year. This carryover amount was not inflation-adjusted under prior IRS guidance (but the health FSA contribution limit was -- capped at $2,500 as adjusted for inflation). IRS Notice 2020-33 creates an inflation adjustment for the carryover amount, indexing the carryover amount to 20% of the FSA contribution limit (rounded to the next lowest multiple of $50). Because the 2020 health FSA contribution limit, as adjusted for inflation, is $2,750, the carryover limit for 2020 will now be adjusted to $550 (20% of $2,750). This adjustment impacts the 2020 plan year, for amounts carried over into 2021. (For the 2019 plan year and amounts carried over into 2020, the limit remains $500.) This change is not temporary. However, the plan must still be amended to reflect the inflation adjusted limit. Any amendment to incorporate this change must be adopted no later than the last day of the first plan year beginning in 2021 (so, by December 31, 2021 for calendar-year plans).

Unanswered Questions
While the Notices provide welcome relief, the guidance leaves many questions unanswered. For instance:

• When and how must participants be notified regarding these changes? The Notice indicates that employers should comply with the notice requirements under Title I of ERISA (which presumably includes SPD/SMM requirements), but presumably any notice under those provisions wouldn’t be legally required until well after a period in which such notices would be relevant.
• Does the flexibility surrounding election changes apply to all qualified benefits under Section 125 (including dental and vision coverage), or does it only apply to medical, health FSA and dependent care FSA benefits?
• Will insurance carriers and reinsurance carriers honor this election change flexibility? The Notice itself suggests that these changes could lead to adverse selection, so we expect that some carriers may object and/or limit the scope of changes they will recognize.

We expect that this will not be the last we hear from the IRS on these issues, so future guidance may shed light on these issues.