IRS offers flexibility on carrying over FSA funds

Accounting

The Internal Revenue Service provided guidance Thursday on how employees and employers can carry over unused money from flexible spending accounts and dependent care assistance programs during the COVID-19 pandemic.

Notice 2021-15 details the relief offered under the stimulus package passed by Congress in December, which included provisions allowing greater flexibility for employee benefit plans in the use of FSA and dependent care assistance funds. The COVID-related Taxpayer Certainty and Disaster Tax Relief Act of 2020, which was part of the overall appropriations package, gave administrators of employee benefit plans extra discretion in 2021 and 2022 to adjust their programs to help employees better meet the unanticipated consequences of the pandemic.

The guidance is part of the IRS effort to respond to the urgent needs of taxpayers and tax professionals who are dealing with the pandemic by providing the guidance necessary to carry out the various provisions of the different COVID-19 relief packages that Congress has passed over the last 12 months. The agency’s first order of business was distributing the $600 Economic Relief Payments authorized by last December’s appropriations package and then launching tax season last week. Now it is rolling out guidance to help implement other parts of the overall stimulus package, even as Congress prepares the next round of relief under the Biden administration’s American Rescue Plan.

The IRS headquarters in Washington.

Andrew Harrer/Bloomberg

In the new guidance, Notice 2021-15 responds to unanticipated changes in the availability of certain medical care and dependent care. “As a result of COVID-19, participating employees are more likely to have unused health FSA amounts or dependent care assistance program amounts at the end of 2020 and 2021,” said the IRS. “Generally, under these plans, an employer allows its employees to set aside a certain amount of pre-tax wages to pay for medical care and dependent care expenses. Amounts spent by the employee are then reimbursed from their designated health FSAs or dependent care assistance programs.”

Notice 2021-15 offers more flexibility for employers in various aspects related to FSAs and dependent care assistance programs:

  • It provides flexibility for the carryover of unused amounts from the 2020 and 2021 plan years.
  • The guidance offers more flexibility to extend the permissible period for incurring claims for plan years ending in 2020 and 2021.
  • It provides flexibility to adopt a special rule pertaining to post-termination reimbursements from health FSAs.
  • It offers flexibility with a special claims period and carryover rule for dependent care assistance programs when a dependent “ages out” during the COVID-19 public health emergency.
  • The guidance allows certain mid-year election changes for health FSAs and dependent care assistance programs for plan years ending in 2021.

The IRS issued earlier guidance that offered flexibility to employers with cafeteria plans through the end of calendar year 2020, during which employers could allow their employees to apply unused health FSA amounts and dependent care assistance program amounts to pay for or reimburse medical care or dependent care expenses. The Taxpayer Certainty and Disaster Tax Relief Act of 2020, which was signed into law on Dec. 27, 2020, also as part of the overall appropriations package, offers similar flexibility for these arrangements in 2021 and 2022.

The IRS noted that millions of employees across the U.S. have access to health FSAs and dependent care assistance programs, which are generally sponsored by their employers under “cafeteria plans.” However, the decision to adjust these employee benefit programs is at the discretion of the employer that sponsors the plan.

“The amounts properly spent are not subject to federal income tax,” said the IRS. “Typically, account funds that are not spent by the employee within the plan year, subject to limited grace periods or certain carryover amounts, are forfeited. In accordance with the Taxpayer Certainty and Disaster Tax Relief Act of 2020, Notice 2021-15 gives employers the option to amend their plans to provide greater flexibility for employees to elect and use these programs during the pandemic without risking the forfeiture of the amounts they have set aside.”

For more information from the IRS on coronavirus tax relief for health plans and retirement plans, click here.

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