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The Impact of the Consolidated Appropriations Act on Flexible Spending Arrangements

In a previous post we summarized the provisions of the Consolidated Appropriations Act, 2021 (“the Act”) governing employee benefit plans, including retirement, welfare, and fringe benefit programs. With this post we begin an in-depth examination of these provisions starting with the Act’s effect on flexible spending arrangements, which provides employers with an expanded set of options to allow mid-year election changes.


Section 125 of the Internal Revenue Code requires that a cafeteria plan not permit the deferral of compensation. The Treasury Department has long interpreted this provision to prohibit participants from using contributions made in one plan year to purchase a benefit that will be provided in a subsequent plan year. Commonly referred to as the “use-or-lose” rule, this requires that unused benefits or contributions remaining as of the end of a plan year (“unused amounts”) be forfeited.

In 2005, the Treasury Department and the IRS modified the use-or-lose rule by adopting a grace period rule, under which a cafeteria plan may permit an employee to use amounts remaining from the previous year (including amounts remaining in a health FSA) to pay expenses incurred for certain qualified benefits during the period of up to two months and 15 days immediately following the end of the plan year.

In 2013, the Treasury Department and the IRS issued a notice further modifying the use-or-lose rule as it applies to health Flexible Spending Arrangements (FSAs). At the plan sponsor’s option, employees participating in health FSAs may be allowed to carry over, instead of forfeiting, up to $500 of unused amounts remaining at year-end. (This carryover amount was recently increased to $550).

In 2020, in response to the COVID-19 pandemic, the Treasury Department and the IRS issued two notices offering additional flexibility for employers with respect to cafeteria plans, and health and dependent care FSAs.

Notice 2020-29 allows employers to amend their Section 125 cafeteria plans to permit employees to spend unused amounts remaining in a health FSA or DCAP as of the end of a grace period ending in 2020 or at the end of a plan year ending in 2020. Under the notice, employers are permitted to:

  • Allow an employee to (i) make a new election, if the employee initially declined coverage, (ii) revoke an existing election and make a new election to enroll in a different coverage option (including changing from self-only to family coverage), (iii) revoke an existing election (provided that the employee has (and attests to) other health coverage not sponsored by the employer.
  • In the case of a health FSA, allow an employee to revoke an election, make a new election, or decrease or increase an existing election.
  • With respect to a dependent care FSA, allow an employee to revoke an election, make a new election, or decrease or increase an existing election.

Notice 2020-33 increased the maximum $500 carryover amount to $550 for at least 2020 and 2021.

Provisions of the Act affecting Cafeteria Plan and FSAs

Division EE, Title II, Section 214 of the Act further extends the FSA carryover and grace periods, and it also provides additional options for terminated employees and a transitional rule for dependent care FSAs.

Unlimited carryovers for 2020 and 2021

In a further loosening of the use-it-or-lose it rule, the Act allows employers to amend their health and dependent care FSAs to permit participants to carryover any unused benefits or contributions for the 2020 plan year in 2021, and for the 2021 plan year into 2022. While carryover of these amounts was permitted under prior law for health FSAs, the Act for the first time extends this option to dependent care FSAs and it eliminates the $550 cap on carryovers.

Extended 12-Month Grace Periods

Employers that have adopted grace period arrangements as part of their health or and dependent care FSAs are free to amend their plans to extend the grace period for plan years ending in 2020 or 2021 to 12 months after the end of the plan year.

Impact of carryover and grace period changes on HSA eligibility

While the effect of the Act blurs the distinction between health FSA carryovers and grace periods, the two approaches still differ respecting their impact on eligibility to participant in a heath savings accounts (HSAs). To be eligible to contribute to an HSA, an individual must be covered under a high-deductible health plan (HDHP) and not covered under a plan that is not a HDHP. An HDHP is a plan with minimum deductibles, and maximum out-of-pocket expenses. A general purpose health FSA is not an HDHP, so an individual with health FSA coverage is generally ineligible to make (or have made on his or her behalf) contributions to an HSA.

  • Carryover arrangements

According to IRS Chief Counsel Advice 201413005, a carryover under a general-purpose health FSA makes the employee ineligible to contribute to his or her HSA for the entire subsequent plan year, even after the carryover is exhausted and even if the employee does not make or receive new health FSA contributions for that plan year.

  • Grace period arrangements

IRS Notice 2005-86 modified the rules governing the interaction between HSAs and Health FSAs in response to a statutory change. For taxable years beginning after December 31, 2006, an employee with no unused benefits (i.e., with a $0 account balance) at the end of a plan year is deemed to not have health FSA coverage during the grace period and is therefore HSA eligible.

In either case, employers may avoid the adverse effect on HSA eligibility of a general-purpose health in these instances by amending their plans to allow or require that the unused amounts be carried over to any of the following HSA-compatible health FSAs, i.e. limited-purpose health FSAs, post-deductible health FSAs, or a combination of a limited-purpose and post-deductible health FSAs.

Distribution rights for terminated employees

Under the Act, health FSAs may continue to provide reimbursements to participants who cease participation in the plan during calendar year 2020 or 2021 through the end of the plan year in which such participation ceased, including any grace period.

Increased eligibility age for dependent care

Under prior law, only expenses for services provided before a dependent child reached age 13 were eligible for reimbursement under a dependent care FSA. The Act changes this by adding a year. This provision applies to expenses incurred during the plan year with respect to which open enrollment ended before January 31, 2020.

Changes in FSA elections absent a qualifying change in status

Expanding on Notice 2020-29, the Act allows employers to amend their health and dependent care FSAs to allow participants to make mid-year election changes in the amount of their FSA elections for the plan years ending in 2021 without a corresponding change in status event. While the law is not entirely clear on the subject, this relief also appears to allow individuals who previously elected to forgo FSA coverage altogether to make a new FSA election. This relief does not extend to other cafeteria plan elections, however. Thus, an individual is not permitted under the provision to change major medical coverage under this provision.

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