Healthcare And Childcare FSA Fix For 2021, Finally

Got leftover money stuck in your healthcare or dependent care FSA? The giant year-end spending package provides tax relief for workers who socked away pre-tax money into flexible spending accounts for 2020 and couldn’t use it because of the coronavirus pandemic. Now employees may be able to carry over all of their unused funds to use later. Even ex-employees might get more time to spend down unused money instead of forfeiting it. 

The temporary special rules for 2021 and 2022 for these tax-advantaged workplace accounts are good news for employers and employees. “Where employers’ hands were tied before, now they have flexibility,” says Jake Mattinson, an employee benefits lawyer with McDermott Will & Emery in Chicago. The catch: Is your employer on board?

Employers got a lot of complaints last year about FSAs when employees realized they were stuck with balances they couldn’t spend down because day care centers were closed and hospitals were postponing elective surgeries. Under the regular rules, you can stash up to $5,000 pretax per year in a dependent care FSA, but if you don’t use the money for the specified year, you lose it. You can put up to $2,750 in a healthcare FSA, and if you don’t use it, you may be able to either use it up during a grace period or carry over $500. 

In May, the Treasury Department came up with a partial mid-year fix: Employers could let workers make a one-time mid-year change to how much money they were putting in their accounts on a prospective basis, and they upped the carryover to $550. That lessened the pain, but Congressional action was needed for a better solution.

The new law allows employers to make these changes:

• allow employees to carry over unused money up to the full annual amount from the plan year 2020 to 2021, and also from the plan year 2021 to 2022 for healthcare and dependent care FSAs
• allow up to a 12-month grace period for employees to incur new expenses and submit claims against unused accumulated funds for plan years ending in 2020 or 2021 for healthcare and dependent care FSAs
• allow midyear election changes on a prospective basis without a change in status event for plan years ending in 2021 for healthcare and dependent care FSAs
• allow dependent care reimbursement up to age 14 in cases where an employee’s dependent turned 13 in 2020 and the employee had leftover funds from 2020 (this special carry forward rule helps employees whose dependents “aged out” during the pandemic) for dependent care FSAs
• allow health FSA participants who stop participating in the plan (ex-employees) during calendar year 2020 or 2021 to continue to receive reimbursements through the end of the year, including grace periods (this post-termination benefit applies to healthcare FSAs, not dependent care FSAs)

Can you count on it? “I don’t think employees should get their hopes up until they hear from their employers because it’s all optional, and some employers are nicer than others,” says Mattinson.

Even if your employer wants to help, trying to implement the tax relief might prove difficult. For employers who offer a high deductible health plan with a health savings account feature, adding a 12-month grace period for a healthcare FSA would cause a conflict because that type of coverage would disqualify an employee from contributing to (or accepting employer contributions to) a health savings account. “There are issues that employers need to think through. If they’re not careful, they might hurt their employees,” Mattinson says. If the carryover goes into a limited purpose healthcare FSA (for dental and vision), then the employee could still contribute to a health savings account.

Note these special rules are temporary, but there’s a good argument for making them permanent. If employees knew they wouldn’t risk losing the money they put in these accounts they would be more keen on contributing. According to Alight Solutions, their clients have seen a decrease in enrollment and contributions in dependent care FSAs for the 2021 plan year compared to 2020 with just 2.1% of participants enrolling, contributing an average of $3,443 compared to 2.6% enrollment and an average $3,611 contribution for 2020.

Further reading on tax relief in the year-end spending package:

New Bigger Charitable Tax Break For 2021

Medical Expense Deduction Tax Relief For 2021 Is Big Win For Seniors

Go Solar! Enhanced Residential Solar Tax Breaks For 2021 And 2022