IRS Clarifies Pandemic-Related Relief for Dependent Care FSAs

As noted in our prior blog posts here and here, the Consolidated Appropriations Act of 2021 (the “Act”) includes several types of relief for flexible spending accounts (“FSAs”), impacting both health and dependent care FSAs.  In February, the IRS issued Notice 2021-15 (the “Notice”), which provides clarifying guidance with respect to the Act’s FSA relief provisions and answers many of the outstanding questions posed by employers following the Act’s passage.  Our prior blog post answers common questions about how the guidance applies to health FSA benefits. Below we describe the key changes in the Act and the Notice (together, the “Relief”) specific to dependent care FSAs.

Dependent Care FSA Carryovers and $5,000 Statutory Limit

  • Regular Rules. Under the regular cafeteria plan rules, dependent care FSAs are not permitted to include a carryover feature.
  • Relief. Under the Relief, a cafeteria plan may allow participants to carry over to the next plan year any unused dependent care FSA amounts remaining at the end of the plan year ending in 2020 or 2021.  There is no dollar limit on the amount that can be carried over.  Under the American Rescue Plan Act of 2021, the exclusion for employer-provided dependent care assistance has been increased from $5,000 to $10,500 (from $2,500 to $5,250 in the case of a separate return filed by a married individual) for 2021.  We anticipate that the IRS will revise Form 2441 for 2021 accordingly.  Thus, a participant (married filing jointly) who carries over, for example, $4,000 from the 2020 plan year into the 2021 plan year and who elects to contribute $3,000 to a dependent care FSA for the 2021 plan year will have $7,000 (i.e., $3,000 election + $4,000 carryover) available to pay dependent care expenses tax-free in 2021.
  • FDBR Note. Employers have certain options when choosing to apply this Relief.  For example, employers can limit the participants for whom the carryover is adopted (subject to the nondiscrimination rules), limit carryovers to a specific amount, and set a deadline before the end of the plan year in which participants must use any carryovers.  Employers adopting a carryover may require employees to enroll in the dependent care FSA (with at least a minimum contribution amount) to have access to any carryover from the prior year.

Extension of the Grace Period

  • Regular Rules. Under the regular cafeteria plan rules, dependent care FSAs can allow amounts remaining at the end of a plan year to be used for the reimbursement of dependent care expenses incurred up to 2½ months after the end of the plan year (the “Grace Period”).
  • Relief. The Relief permits employers to extend Grace Periods to up to 12 months after the end of the plan year for the plan years ending in 2020 or 2021.  This would allow dependent care FSA amounts remaining at the end of the 2020 or 2021 plan year to be used for the reimbursement of dependent care expenses incurred for up to 12 months after the end of the applicable plan year.  Unused amounts from one plan year that remain available at the end of the extended Grace Period (i.e., at the end of either 2021 or 2022, as applicable) need not be forfeited and may be made available during the next Grace Period.  However, for a plan year ending in 2022, the grace period in the plan year ending in 2023 will be limited to the first 2½ months of the plan year.
  • FDBR Note. Employers that wish to provide the Relief will need to choose between providing the carryover opportunity or an extended Grace Period because the Notice confirms that a dependent care FSA may not have both.  Generally, the carryover and the extended Grace Period provide similar relief because both features allow dependent care FSA amounts remaining at the end of the 2020 and 2021 plan years to be used for the reimbursement of dependent care expenses incurred in the following plan year.  However, employers should consider that the extended Grace Period would allow employees who have ceased participation to continue to incur claims until the end of the next plan year.

Dependent Care FSA Special Rules for Dependents Who Aged Out During the Pandemic

  • Relief. Under the Relief, employers can amend their dependent care FSAs to allow participants who elected dependent care FSA coverage for the 2020 plan year during an enrollment period that ended on or before January 31, 2020, and whose dependent child(ren) turned age 13 during the 2020 plan year, to continue to use their dependent care FSA funds for the child’s expenses through the end of the 2020 plan year.  In addition, if there is still a balance remaining in the participant’s dependent care FSA at the end of the 2020 plan year, the participant may use that balance for the child’s expenses into 2021, until the child reaches age 14.
  • FDBR Note. Employers are not required to extend the special age limit Relief and may limit reimbursable expenses to expenses incurred for the care of a dependent child who is under age 13 or who is under a specified age less than age 13; and if an employer does decide to extend the special age limit relief, the Relief ceases once the child attains age 14.

Reporting Requirements for Dependent Care FSAs.  Generally, employers may report in Box 10 of Form W-2 the salary reduction amount elected by the employee for the year for dependent care assistance (plus any employer matching contributions) and are not required to adjust the amount reported in Box 10 to take into account amounts that remain available in a Grace Period.  The Notice indicates that the Treasury Department and the IRS anticipate that the same employer reporting rules will apply in 2021 and 2022.  The Notice confirms that any amount carried forward from 2019 and used in 2020, whether through a carryover or an extended Grace Period, is treated as an amount that remains available in a grace period and individuals should complete Part III of Form 2441 for 2020 accordingly.  As noted above, pending IRS revisions to Form 2441 and related instructions, individuals may benefit in 2021 from the increase in the permitted exclusion under dependent care assistance plans to $10,500/$5,250.

Plan Amendments.  If dependent care FSA relief is provided, the plan can be amended retroactively, provided that:  (i) the amendment is adopted not later than the end of the calendar year beginning after the end of the plan year in which the amendment is effective (e.g., calendar year 2020 plan amendments must be adopted on or before December 31, 2021); (ii) the plan is operated consistently in accordance with the terms of the amendment; and (iii) the employer notifies eligible employees of the changes to the plan.

Contact your Faegre Drinker benefits attorney to discuss the impact of the FSA relief provisions on your plans.