IRS Temporarily Relaxes Section 125 Cafeteria Plan Election Change and “Use It or Lose It” Rules in Response to COVID-19 Pandemic

On May 12, 2020, in Notice 2020-29, the IRS substantially relaxed and simplified cafeteria plan election-change and grace-period rules.

The Permitted Changes

Notice 2020-29 permits employers to adopt one or more of the following changes to existing cafeteria plans for 2020:

• An employee who did not elect group health plan coverage before the beginning of the current plan year may now elect to be covered for the rest of the year.
• An employee who did elect group health plan coverage before the beginning of the current plan year may elect different health plan coverage for the rest of the year.
• An employee who did elect group health plan coverage may revoke that election for the rest of the plan year if he or she enrolls in other coverage, such as under his or her spouse’s employer’s health plan or through an Affordable Care Act (“ACA”) Exchange.
• An employee may revoke his or her health flexible spending account (“FSA”) election, make a new health FSA election, or increase or decrease his or her health FSA election for the rest of the year.
• An employee may revoke his or her dependent care assistance plan (“DCAP”) election, make a new DCAP election, or increase or decrease an existing DCAP election for the rest of the year.
• The “grace period” for a health FSA or DCAP balance that ended in 2020 (e.g., the grace period of a calendar year cafeteria plan that ended March 15, 2020), may be extended to December 31, 2020, thus in most cases potentially restoring what were otherwise forfeitures of health FSA and DCAP credit balances carried over from 2019.

Employee-Certification Requirement

In the case of an employee who elects to stop being covered by his or her employer’s health plan, the employee must attest that he or she has alternative health-plan coverage. Notice 2020-29 provides a form that an employer may use for obtaining the attestation. Notice 2020-29 also provides that an employer may rely on the employer’s attestation unless the employer has “actual knowledge” that the attestation is false.

Should an Employer Adopt the Permitted Changes for 2020?

These rule changes are optional for employers, who may choose to adopt all of them, some of them, or none of them. Because these new rules will provide welcome financial relief for many employees and will simplify plan administration in connection with processing employee change-in-coverage requests, most employers will want to review them immediately and consider adopting them. However, in the case of employer health-plan coverage, the rule changes present issues of adverse selection and should be adopted only in consultation with an employer’s group health insurer or stop-loss carrier. Additionally, an employee who drops coverage under an employer’s health plan that is considered unaffordable under the ACA’s rules, and who obtains subsidized coverage through an ACA exchange, could cause an employer to incur an affordability penalty under the ACA.

Plan Amendments

An employer that wishes to adopt some or all of the above changes must adopt a plan amendment by December 31, 2021. In most cases, the immediate adoption of a short amendment to an employer’s Section 125 plan, prepared and adopted with the help of the employee’s employee benefits counsel, will be advisable. Please contact any of the Clark Hill Employee Benefit and Executive Compensation attorneys identified at the end of this Alert if you wish to know more about the IRS’s relaxation of the Section 125 cafeteria plan change in election and grace period rules for 2020.

Requirement for Summary of Material Modifications (“SMM”)

An employer that adopts any of the permitted changes should communicate them to plan participants through a short Summary of Material Modifications that can be prepared by employee benefits counsel in conjunction with the required amendment.

Other Changes and Clarifications

Notice 2020-29 also clarifies that recent rule changes permitting first-dollar coverage of COVID-19-related expenses by high deductible health plans and permitting first-dollar coverage of telehealth for plan years beginning on or before December 31, 2021, are effective as of January 1, 2020. Also, in companion guidance (Notice 2020-33), the IRS indicates that beginning with 2020 it will index the $500 amount that may be carried over in an employee’s health FSA from year to year. The amount for 2020 is $550.

Please contact these attorneys for more information: Edward C. Hammond, Brad Oxford, Luke D. Bailey, James R. Olson, and Charles M. Russman.