New legislation has enhanced the rules for flexible spending accounts (FSAs). Generally, participants in FSSAs will have more flexibility in managing their accounts, albeit temporarily. Key point: Employers may choose to implement the new law changes, but are not required to do so.
Background: There are two types of FSAs that employers may offer to employees—one for healthcare expenses and one for dependent care expenses. With either type of account, contributions are made on a pre-tax basis, so employees save income and payroll taxes. And, when withdrawals are made, payouts are exempt from tax if the money is used to pay for qualified expenses.
The maximum contribution for healthcare FSAs is $2,750. It is $5,000 for dependent care FSAs.
Two new laws—the Consolidated Appropriations Act (CAA) and the American Rescue Plan Act (ARPA)—provide additional benefits, as clarified by new IRS guidance. This includes these four significant changes.
- Grace period: For years, participants were subject to a “use-it-or-lose it rule,” where any remaining funds in the FSA were forfeited at the end of the plan year. More recently, employers were able to grant a 2½-month grace period. Under the CAA, an employer may allow a 12-month grace period for FSA funds in a plan year ending in 2020 or 2021.
- Carryovers: As an alternative to a grace period, an employer may allow participants to carry over up to $550 in unused funds to the next plan year. But this benefit could not be combined with a grace period and was only available for healthcare FSAs. Now the CAA extends the tax break to dependent care FSAs, allows unlimited carryover amounts from 2020 to 2021 and 2021 to 2022 and permits employers to offer both a grace period and a carryover.
- Dependent care increases: Normally, a dependent care FSA can provide for payment of qualified expenses for children under age 13. The CAA increases the maximum age threshold to 14 for 2021. Also, ARPA hikes the contribution limit for dependent care expenses in 2021 to $10,500—more than double the usual limit.
- Mid-year elections: Generally, an FSA election for a plan year is irrevocable, barring a change in status. Under the CAA and IRS guidance, a plan can be amended to allow a participant to make changes to their healthcare or dependent care FSA anytime during a plan year ending in 2021, even if the participant does not have a change in status. This includes enrolling, dis-enrolling or increasing or decreasing contributions.
An employer may allow election changes on a one-time-only basis or on a specific date. Furthermore, it can limit mid-year election changes to certain actions (e.g., increasing or decreasing contributions).
Finally, the latest IRS guidance explains that a carryover from a prior year does not affect the contribution limit for the current year. For example, if you carry over $5,000 from a dependent care FSA for 2020 because your child’s day care was cancelled, you can still contribute $10,500 for 2021, for a total of $15,500.
Important: The guidance from the IRS covers other technicalities. Contact your JMF professional advisors for more information.
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