United States

New IRS guidance on health FSAs and dependent care assistance programs


Original – Feb. 22, 2021: Link to original article

Update – May 12, 2021:

On Feb. 18, 2021, the IRS published Notice 2021-15 which provides guidance on health flexible spending arrangements (FSAs) and dependent care assistance programs (DCAPs). This notice addressed provisions in the Consolidated Appropriations Act (CAA) enacted on Dec. 27, 2020, which give employers greater flexibility in administering their health FSAs and DCAPs due to the COVID-19 pandemic. 

On March 11, 2021, the American Rescue Plan Act (ARPA) was enacted which increased the contribution limit for DCAPs for 2021. The IRS has now released Notice 2021-26 to further address the CAA and ARPA changes for DCAPs.


Many employers offer health FSAs and DCAPs to provide a tax-free means for employees to pay for certain expenses, up to IRS limits. These arrangements can be funded by employee pretax payroll deductions and by employer contributions through section 125 cafeteria plans. Health FSAs are for medical expenses and the contribution limit is $2,750 for 2020 and 2021. DCAPs, also known as dependent care flexible spending accounts (FSAs) are for dependent care expenses, such as daycare costs for children. The contribution limit for DCAPs is $5,000 ($2,500 if married filing separately) for 2020 and $10,500 ($5,250 if married filing separately) for 2021. 

Generally, employees must enroll in the arrangements prior to the start of a plan year, and can only make election changes during the plan year if they have a change in status under IRS rules. Unused amounts at the end of the plan year are forfeited unless the plan includes a grace period or carryover option. Employers can design their plans to allow employees a grace period of up to two and a half months after the end of the plan year to incur expenses to use up prior year balances in a health FSA or DCAP. Alternatively, health FSAs (but not DCAPs) can provide a carryover of unused amounts to the next plan year of up to $500.

2020 changes

In 2020, the IRS issued Notices 2020-29 and 2020-33 to liberalize the health FSA and DCAP rules in response to the COVID-19 pandemic. These notices provided the following changes:

  • Mid-year elections. Employees could revoke a health FSA or DCAP election, make a new election, or decrease or increase an existing election on a prospective basis in 2020 without a change in status. In addition, employees could enroll in employer-sponsored health coverage, change their plan selection or revoke an election mid-year. This additional flexibility was limited to plans that already allowed mid-year election changes.
  • Grace periods. Employees could apply unused amounts in a health FSA or DCAP at the end of a grace period or plan year ending in 2020 to expenses incurred through Dec. 31, 2020.
  • Carryovers. Health FSA carryovers were increased to $550 and could be used for expenses incurred through Dec. 31, 2020.

Employers were not required to implement these revised rules, but could choose to do so to help employees avoid forfeitures because of changes in their circumstances due to the pandemic. To implement the new rules, employers were to (1) notify employees of the plan changes, (2) operate their plans in accordance with the new rules and (3) adopt appropriate plan amendments by Dec. 31, 2021, which could be effective retroactively to Jan. 1, 2020.

2021 changes

Notice 2021-15 clarified the temporary rules regarding health FSAs and DCAPS included in the CAA. As with the 2020 changes, employers have discretion on whether to adopt any of these temporary rules allowable under the CAA. The CAA and the notice provide the following:

  • Mid-year elections. Employees can revoke a health FSA or DCAP election, make a new election, or decrease or increase an existing election on a prospective basis without a change in status for plan years ending in 2021. In addition, with regard to employer-sponsored health coverage, employees can be allowed to make the following mid-year election changes on a prospective basis:  (1) elect the coverage if the employee initially declined the coverage, (2) select a different health plan sponsored by the same employer and (3) revoke an existing election to enroll in health coverage not sponsored by the employer.
  • Grace periods. Employers can extend the health FSA or DCAP grace period for plan years ending in 2020 or 2021 to 12 months after the end of such plan year.
  • Carryovers. Employees can carry over unused amounts in a health FSA or DCAP in a plan year ending in 2020 to the plan year ending in 2021. Likewise, carryovers can be made from the plan year ending in 2021 to the plan year ending in 2022. This carryover feature is available even if the plan does not currently have a carryover or grace period provision. There is no dollar limit on the carryover unless the employer chooses to impose a limit.
  • Health FSA post-termination reimbursements. Employees who cease participating in a health FSA during calendar year 2020 or 2021 may continue to receive reimbursements from unused amounts through the end of the plan year in which participation ceased, including any grace period. Under this new rule, employees can be reimbursed for expenses incurred after termination of employment even if they don’t elect COBRA.
  • DCAP age restrictions on dependents. Normally, employees can only use DCAP funds for dependents age 12 or under. However, under a temporary rule, employees can use DCAP funds for dependents who turn age 13 during the last plan year with a regular enrollment period that ended on or before Jan. 31, 2020, or the subsequent year if the employee had an unused balance at year end.

As with the 2020 changes, employers that choose to adopt any of the 2021 changes must formally amend their plans to do so. The amendment can be retroactive, but must be adopted not later than Dec. 31 of the first calendar year beginning after the end of the plan year in which the amendment is effective. In addition, the employees must be informed of the changes and the plan must be operated consistently with the terms of the amendment.

Additionally, the notice discusses the impact on health savings account (HSA) eligibility when an employee participates in a health FSA that adopts the above changes. COBRA for health FSAs is also addressed.

The notice also indicates that health FSAs may be amended to provide for reimbursement of expenses for menstrual care products and over-the-counter drugs without prescriptions incurred on or after Jan. 1, 2020, in accordance with the CARES Act passed in 2020.

Additional 2021 changes

Notice 2021-26 clarifies that DCAP benefits that would have been excluded from a participant’s income if used in 2020 or 2021 are still excluded from the participant’s income when carried over from a plan year ending in 2020 or 2021 or are permitted to be used pursuant to an extended claims period. In addition, these DCAP benefits are disregarded for purposes of application of the limits for the subsequent tax years of the employee. This clarification is to Notice 2021-15, which is based on the CAA. 

Due to ARPA, DCAP limits are increased to $10,500 ($5,250 if married filing separately) for only one year, the tax year that starts in 2021. A DCAP can be amended retroactively to increase the contribution limits allowed under the plan if (1) the amendment is adopted no later than the last day of the plan year in which the amendment is effective and (2) the plan is operated consistent with the terms of the amendment from the effective date of the amendment through the date the amendment is adopted. 

Since the increased limits under ARPA are based on the employee’s tax year and not the plan year, fiscal year plans that incorporate the increased limits will need to be careful when applying the limits. Notice 2021-26 points out that the increased exclusion amount will not apply to the reimbursement of expenses incurred in 2022 when a DCAP has a non-calendar plan year that starts in 2021 and ends in 2022. For example, an employee electing to contribute $10,500 for a plan year starting on July 1, 2021, may have taxable income in 2022 if the employee incurs and receives reimbursement of more than $5,000 of dependent care expenses in 2022. This is because the employee’s tax year limit in 2022 will revert to $5,000, per current law. Therefore, employers with fiscal year DCAPs should carefully review Notice 2021-26.



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