In Notice 2020-23[1] the IRS revised the maximum amount a cafeteria plan may allow a participant to carry over to the next year for a medical flexible savings account and clarified that a health plan may reimburse individual insurance policy premium expenses incurred prior to the beginning of the current year.

Health FSA Carryover Rule

In 2013, the IRS in Notice 2013-71 provided that a cafeteria plan with a flexible spending account could provide for a carryover of up to $500 into the following year, reducing the impact of the “use it or lose it” rule when an employee who deferred more to the account than he/she incurred in medical expenses for a year would forfeit the extra deferral.

This $500 amount was not indexed for inflation, while the maximum annual deferral is tied to inflation. When Notice 2013-71 was issued, the maximum deferral amount was $2,500. In 2020 that amount has grown to $2,750. Notice 2020-23 allows a plan to permit a participant to carryover up to 20% of the year’s maximum contribution, thus effectively tying the carryover to inflation.

The Notice provides:

…[T]his notice expands the exception to the prohibition on providing deferral of compensation through a § 125 cafeteria plan described in Notice 2013-71, which provides that a § 125 cafeteria plan may allow up to $500 of unused amounts in a participant’s health FSA as of the end of a plan year to be carried over to pay or reimburse the participant for medical care expenses incurred in the immediately following plan year. Specifically, this notice increases the maximum $500 carryover amount for a plan year to an amount equal to 20 percent of the maximum salary reduction contribution under § 125(i) for that plan year. Because, by statute, the increase to the § 125(i) limit is rounded to the next lowest multiple of $50, increases to the maximum carryover amount, as the result of that indexing, will be in multiples of $10 (20 percent of any $50 increase to the § 125(i) limit). Thus, the maximum unused amount from a plan year starting in 2020 allowed to be carried over to the immediately following plan year beginning in 2021 is $550 (20 percent of $2,750, the indexed 2020 limit under § 125(i)).

Any plan wishing to take advantage of the enhanced carryover will need to amend the plan document to provide for this carryover. The IRS provides

As a general rule, an amendment to a § 125 cafeteria plan to increase the carryover limit must be adopted on or before the last day of the plan year from which amounts may be carried over and may be effective retroactively to the first day of that plan year, provided that the § 125 cafeteria plan operates in accordance with the guidance under this notice and informs all employees eligible to participate in the plan of the carryover provision. Because § 125(d)(1) provides that a § 125 cafeteria plan must be a written plan, a § 125 cafeteria plan offering a health FSA may not utilize the increased carryover amount permitted under this notice for a plan year that begins in 2020 (or a later year) unless the plan is written in a manner that incorporates the increase by reference or the plan is timely amended to set forth the increased amount. Accordingly, a plan may be amended to adopt the increased carryover amount for a plan year that begins in 2021, for example, at any time on or before the last day of the plan year that begins in 2021; see section III.C. for a special amendment timing rule for the 2020 plan year. The ability to amend a plan to increase the carryover limit does not include the ability to allow employees to make new elections under the plan (but see relief for the 2020 plan year in section III.C.).

The special timing rule described above for 2020 reads as follows:

With respect to the requirement to amend the written plan, Notice 2020-29 provides that an amendment under this notice for the 2020 plan year must be adopted on or before December 31, 2021, and may be effective retroactively to January 1, 2020, provided that the employer informs all individuals eligible to participate in the § 125 cafeteria plan of the changes to the plan.

A special rule found in Notice 2020-29, issued the same day, will allow employees whose employer’s plans are amended in 2020 to increase the amount eligible for carryover to revise elections to defer to take advantage of this increase (although the relief in Notice 2020-29 isn’t limited to this case):

However, the Treasury Department and the IRS are simultaneously issuing a notice that, among other things, for the remainder of 2020, allows employers to permit mid-year elections under a § 125 cafeteria plan regarding a health FSA, including the ability to make an initial election to fund a health FSA, provided the changes are applied only prospectively. See Notice 2020-29, 2020-22 IRB __. Although Notice 2020-29 permits this flexibility temporarily in response to the public health emergency posed by the 2019 Novel Coronavirus, Notice 2020-29 does not limit the relief to individuals affected by the pandemic. Accordingly, individuals who, during 2020, wish to increase their health FSA contributions, or begin to make health FSA contributions, as a result of the increased carryover amount permitted under this notice may do so in accordance with Notice 2020-29. Although only future salary may be reduced under the revised election, amounts contributed to the health FSA after the revised election may be used for any medical care expense incurred during the first plan year that begins on or after January 1, 2020.

Reimbursement Timing for Individual Coverage HRA Plans

The Notice also contains a rule for reimbursing individual coverage aimed at making it administratively simpler to implement an individual coverage HRA. The new timing rule provides:

As discussed in section II.B. of this notice, a health plan, including a premium reimbursement plan in a § 125 cafeteria plan or an individual coverage HRA, may not reimburse medical care expenses incurred before the beginning of the plan year and qualify for exclusion from income and wages under §§ 105 and 106. Medical care expenses are treated as incurred when the covered individual is provided the medical care that gives rise to the expense, and not when the amount is billed or paid. This notice provides that a plan is permitted to treat an expense for a premium for health insurance coverage as incurred on (1) the first day of each month of coverage on a pro rata basis, (2) the first day of the period of coverage, or (3) the date the premium is paid. Thus, for example, an individual coverage HRA with a calendar year plan year may immediately reimburse a substantiated premium for health insurance coverage that begins on January 1 of that plan year, even if the covered individual paid the premium for the coverage prior to the first day of the plan year.

[1] Notice 2020-23, May 12, 2020, https://www.irs.gov/pub/irs-drop/n-20-33.pdf (retrieved May 12, 2020)