United States: Increased flexibility for taxpayers in section 125 cafeteria plans in response to COVID-19

In brief

On May 12, 2020, the IRS released Notice 2020-29 (the "notice") providing greater flexibility to make mid-year election changes under code section 125 cafeteria plans during 2020 with respect to employer-provided health coverage and health and dependent care flexible spending accounts ("FSAs"). The notice also provides additional time in which unused amounts in FSAs can be used to pay expenses and avoid forfeiture.  


Mid-year Election Changes

As background, cafeteria plans are the vehicle that allow employees to elect to pay their share of benefit premium costs for certain welfare benefits (for example, the employee premium portion paid for medical coverage) on a pre-tax basis rather than paying for those costs on an after-tax basis. In general, employee cafeteria plan elections must be made prior to the first day of the plan year and cannot be changed during the plan year except for specific change in status type events permitted under the relevant regulations (for example, the birth of a child). 

Under the notice, for the remainder of 2020, a cafeteria plan may permit prospective election changes (regardless of reason) to employer-sponsored health plan coverage or contributions to a health or dependent care FSA. As examples, the notice provides plans may be amended to allow employees to: 

  • Make a new election for employer-sponsored health coverage if the employee initially declined to elect employer-sponsored health coverage; 
  • Revoke an existing election for employer-sponsored health coverage and make a new election to enroll in different coverage (including changes from self-only coverage to family coverage); 
  • Revoke an existing election for employer-sponsored health coverage, 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 (the notice includes a model attestation clause); or 
  • Revoke an election, make a new election, or decrease or increase an existing election regarding a health or dependent care FSA on a prospective basis.
  • Employers are not required to permit these election changes. If adopted, these changes can be subject to additional reasonable limitations provided those limitations do not cause the plan to run afoul of the normally applicable nondiscrimination requirements.

Extended Claims Period for FSA Accounts

The notice also extended the period for making claims under FSAs. FSAs are subject to a "use it or lose it" rule which generally provides that FSA funds which are not used by the end of the plan year are forfeited. However, as an exception to the "use it or lose it" rule, plans are permitted to adopt a "grace period" of up to 2 ½ months after the end of the plan year during which a participant may apply unused amounts to pay qualified expenses incurred during the grace period. As another alternative exception to the "use it or lose it" rule, plans are allowed to use a “carryover” rule that permits the carryover of up to $500 of unused amounts to pay expenses incurred during the following plan year.

Under the notice, an employer may amend its plan to permit employees to apply unused amounts remaining in a FSA as of the end of a grace period ending in 2020 or a plan year ending in 2020 to pay qualifying expenses incurred through December 31, 2020. For example, if a plan had a grace period that ended March 15, 2020 for the 2019 plan year, the plan could be amended to permit any unused amounts in the FSA as of March 15, 2020, to be used to pay qualifying expenses incurred through December 31, 2020. For a non-calendar plan year ending in 2020, the notice would allow a plan using the carryover rule to be amended to permit unused amounts (including amounts greater than $500) to be used to pay expenses incurred during the remainder of 2020. 

Plan amendments

Implementation of the increased flexibility provided by the notice will require plan amendments. Employers have until December 31, 2020 to make any required amendments. Employers can adopt these changes effective immediately and wait do the required amendments as long as the plan is operated in accordance with the notice and participants are provided notice of the changes. 

Implementation considerations

While the increased flexibility under the notice may be beneficial for employees, employers will want to consider the ramifications of making changes. This increased flexibility may result in increased administrative costs and, as noted in the notice, may lead to “adverse selection” (i.e., where higher-risk or sick individuals who have greater coverage needs purchase health insurance while healthy people delay or decide to abstain).

For assistance evaluating the changes provided in the notice, please contact your Baker McKenzie employment & compensation attorney.

Contact Information

© 2021 Baker & McKenzie. Ownership: This site (Site) is a proprietary resource owned exclusively by Baker McKenzie (meaning Baker & McKenzie International and its member firms, including Baker & McKenzie LLP). Use of this site does not of itself create a contractual relationship, nor any attorney/client relationship, between Baker McKenzie and any person. Non-reliance and exclusion: All information on this Site is of general comment and for informational purposes only and may not reflect the most current legal and regulatory developments. All summaries of the laws, regulation and practice are subject to change. The information on this Site is not offered as legal or any other advice on any particular matter, whether it be legal, procedural or otherwise. It is not intended to be a substitute for reference to (and compliance with) the detailed provisions of applicable laws, rules, regulations or forms. Legal advice should always be sought before taking any action or refraining from taking any action based on any information provided in this Site. Baker McKenzie, the editors and the contributing authors do not guarantee the accuracy of the contents and expressly disclaim any and all liability to any person in respect of the consequences of anything done or permitted to be done or omitted to be done wholly or partly in reliance upon the whole or any part of the contents of this Site. Attorney Advertising: This Site may qualify as “Attorney Advertising” requiring notice in some jurisdictions. To the extent that this Site may qualify as Attorney Advertising, PRIOR RESULTS DO NOT GUARANTEE A SIMILAR OUTCOME. All rights reserved. The content of the this Site is protected under international copyright conventions. Reproduction of the content of this Site without express written authorization is strictly prohibited.