IRS Issues Guidance for Optional FSA Rollovers, Extended Grace Periods

The 2021 Consolidated Appropriations Act (CAA) introduced new optional FSA provisions that grant employees improved account flexibility in the new year—including key updates to health FSA and dependent care FSA funds and claims. In February 2021, the IRS released guidance pertaining to these new temporary rules. Here’s what your team needs to know.

New COVID-19 Legislation Spurs Change to FSA Provisions

Only a few days before the end of 2020, Congress passed a new coronavirus stimulus bill to address many of the pandemic challenges faced by employers and employees alike. On Dec. 27, 2020, the president signed the bill into law.

While legal experts and HR teams are still digging into the details—the CAA clocks in at 5,000-plus pages—one important takeaway from the bill is added flexibility for flexible spending accounts (FSA) and dependent care FSA funds.

Why Did Congress Adjust FSA Requirements?

Simply put, many FSA and dependent care FSA owners didn’t use their funds as expected in 2020.

For example, it’s common for employees to use FSA funds to pay for childcare services. During the pandemic, countless people worked from home and many opted to watch their children instead of sending them to daycare. Some childcare services were closed for significant portions of the year as well. 

Unlike most health savings account (HSA) funds, FSA dollars tend to expire at the end of the calendar or plan year. Thanks to this convergence in conditions, many employees faced losing their contributions for the year until Congress intervened in late December 2020.

IRS Issues Guidance on Expanded FSA Flexibility and Carryover Extension

Now, employers are empowered to make 2020 plan year FSAs and dependent care FSAs friendlier for employees in two different ways—including the optional suspension of "use it or lose it" provisions for up to two years.

For health FSAs, these include: 

1. 1. Unused Funds Carryover: Employers can allow the carryover of unused FSA and dependent care FSA funds (with no dollar limit) from a plan year ending in 2020 and/or 2021 to a plan year ending in 2021 and/or 2022.
   2. Extended Grace Period: Employers can extend the FSA and dependent care grace period to up to 12 months after the end of the plan year for a plan year ending in 2020 and/or 2021. This option allows FSA holders to file a claim much later for an eligible expense in 2020. (Reminder: The typical grace period of coverage indicates an additional two-and-a-half-month timeframe in which FSA owners can incur expenses after the end of the plan year.)
   3. Post-Termination Reimbursement: Employers can allow employees who stopped participating in an FSA in 2020 or 2021 to continue receiving reimbursements from unused benefits or contributions through the end of the plan year when participation ended. 
   4. Contribution Adjustments: Employers can allow employees to change their FSA contributions for plan years ending in 2021 without the need for a qualifying life event. 

For dependent care FSAs, these include the carryover for unused funds, the extension of grace periods, and contribution adjustments, as well as a carry-forward option for dependents who have aged out of the qualified dependent care range. Now, reimbursement expenses can be permitted for children up to age 14 instead of up to age 13.