IRS Gymnastics With Code Section 125 for FSAs: Notice 2021-15

March 01, 2021

As discussed in our earlier LawFlash, the Consolidated Appropriations Act, 2021 (Act) contains certain permissible provisions plan sponsors may adopt to offer employees greater flexibility under a healthcare flexible spending account (HCFSA) and a dependent care flexible spending account (DCFSA). While this flexibility was welcome news for plan sponsors, the Act left some unanswered questions. The IRS issued Notice 2021-15 (Notice) in an effort to address these unanswered questions. While the Notice clarifies the permissible opportunities available under the Act, the IRS twists long established rules under Section 125 of the Code to perform a double backflip with three twists in an effort to offer plan sponsors more flexibility than a skilled gymnast needs to perform a flawless balance beam routine.

The Notice offers up a cornucopia of additional opportunities that create administrative burdens and may be too costly for a third-party administrator to implement given the emphasis in the Notice that these permissible opportunities are all temporary in duration. In short, plan sponsors may decide many of the opportunities offered in the Notice are too costly, burdensome, and not worth the effort. All of the opportunities are optional and plan sponsors can pick and choose which to implement. While the Notice attempts to score a perfect 10 with plan sponsors, it remains to be seen if the IRS will appear on the Wheaties box any time soon. Below are some key takeaways from the Notice.

Carryovers and Extended Grace Periods for a HCFSA and DCFSA

Under the Act, a plan sponsor may permit the carryover of unlimited amounts of unused HCFSA or DCFSA balances from the plan year ending in 2020 and 2021 into the plan year ending in 2021 and 2022, respectively. For plans with a grace period, the Act permits the extension of an existing grace period for a plan year ending in 2020 or 2021 for 12 months after the end of the plan year for both an HCFSA and a DCFSA. The Notice clarifies these permissible opportunities in the following ways:

  • The carryover may be limited to all or just part of the unused dollars remaining in a HCFSA or DCFSA at the end of the plan year ending in 2020 or 2021.
  • The plan sponsor may require an employee to maintain a minimum election in the HCFSA or a DCFSA in order to have access to unused carryover amounts from the prior plan year.
  • A plan sponsor can limit the carryover to apply only up to a specified date during the plan year.
  • A plan sponsor may permit an extension of a grace period for any number of months and it is not required to extend the grace period for a full 12 months.
  • A plan sponsor may amend its plan to allow each employee to opt out of any carryover or extended grace period under a HCFSA to preserve HSA eligibility. In the alternative, a plan sponsor may allow employees to make mid-year election changes to be covered by a general purpose HCFSA for part of the year and an HSA-compatible HCFSA for part of the year.
  • Subject to applicable nondiscrimination rules, an employer that sponsors more than one cafeteria plan may decide, within its discretion, to adopt the carryover feature or extended grace period for some but not all cafeteria plans.
  • Amounts carried over or made available during a grace period will not be taken into account for purposes of the nondiscrimination rules applicable to Section 125 cafeteria plans and to DCFSAs under Section 129 of the Code.
    • Practical Considerations. Permitting participants the opportunity to opt out of a carryover or grace period under a HCFSA, or the choice to participate in a general purpose HCFSA or a HSA-compatible HCFSA, on an employee-by-employee basis, is an administrative burden. Under current guidance, a carryover under a HCFSA can be converted to an HSA-compatible HCFSA automatically by plan design. This approach appears to now be available during an extended grace period as well. Converting the HCFSA by plan design is the less burdensome approach and will continue to give participants access to the HCFSA on a limited-scope basis while preserving HSA eligibility. The HSA-compatible HCFSA may also be post-deductible giving participants the added benefit of using any dollars remaining in a HCFSA for 213(d) expenses once the participant’s deductible has been met under the high deductible health plan (HDHP). This approach may not be practical for a plan sponsor that currently does not offer an HSA-compatible HCFSA and it may be too costly to implement one given the limited duration of these rules.

Extended Time Periods for Incurring Claims

Under the Act, a plan sponsor may permit an employee who ceases participation in a HCFSA during the calendar year 2020 or 2021 to continue to receive reimbursements from unused benefits or contributions through the end of the plan year in which participation ceased (including any grace period, if applicable). The Notice clarifies this permissible opportunity in the following ways:

  • An employee may cease participation as a result of termination of employment, change in employment status, or a new election to revoke contributions.
  • A plan sponsor may adopt a period that ends before the end of the plan year, during which employees who have ceased participation in a plan may continue to receive reimbursements.
  • A plan sponsor may permit employees who cease participation to continue to receive reimbursements for eligible claims incurred after the date participation ceases in the HCFSA.
  • An employee who ceases participation as a result of the termination of employment or other COBRA qualifying event must still be offered COBRA coverage. The plan sponsor may allow the employee to request a reimbursement for up to the amount contributed to the HCFSA as of the date of the qualifying event or the employee may elect COBRA coverage to have access to the HCFSA.
    • Practical Considerations. This spend down feature mimics the spend down feature that has always been available under a DCFSA.

Age of an Eligible Dependent Under DCFSA

Under the Act, a plan sponsor is permitted to extend the eligible dependent child age under a DCFSA from under age 13 to under age 14, if the participant’s enrollment period ended before January 31, 2020 and the eligible dependent child aged out of coverage during the 2020 plan year.

  • A plan sponsor that amends its DCFSA to permit reimbursements for an eligible dependent under age 14 can reimburse up to the dollar amount remaining in the participant’s DCFSA as of the end of the 2020 plan year, toward any expenses incurred for an eligible dependent child that aged out during the 2020 plan year.
    • Practical Considerations. This may present additional administrative challenges for a participant who has other eligible dependent children and elects to participate in the DCFSA during the 2021 plan year as well. Any third-party administrator will need to manage reimbursements for each eligible dependent child (the one who aged out with 2020 dollars vs those under age 13 for the current plan year with 2021 dollars).

Permissible Prospective Election Changes

The Act permits prospective election change opportunities to a HCFSA or a DCFSA for plan years ending in 2021, without regard to a change in status. A new opportunity offered under the Notice, that was not available previously under the Act, is to permit employees to make prospective election changes under employer-sponsored group health plan coverage (limited to medical, dental, or vision coverage (Health Coverage)). This permits employees, absent a change in status opportunity to prospectively: (1) make a new Health Coverage election; (2) revoke an existing Health Coverage election and elect other coverage offered by the plan sponsor; or (3) revoke an existing Health Coverage election and attest in writing to obtaining other health coverage not sponsored by the employer.

  • A plan sponsor may allow amounts contributed to a HCFSA or a DCFSA, after a prospective election change opportunity, to be used for any eligible expenses incurred retroactively to the start of the plan year that begins on or after January 1, 2021. For example, under a calendar year plan, an employee who newly enrolls in a HCFSA or DCFSA on March 1, 2021 pursuant to a prospective election change opportunity, may use his/her HCFSA or DCFSA for claims incurred back to January 1, 2021 when the employee was not enrolled in the HCFSA or DCFSA.
  • Plan sponsors may allow participants to revoke elections under a HCFSA or DCFSA as of a future specified date.
    • Practical Considerations. The Notice mimics what was issued last spring by allowing employers to essentially place any restrictions on these prospective election change opportunities. Furthermore, plan sponsors may also offer some of the election change opportunities without offering all. In other words, a plan sponsor may permit an employee to make a change under the plan, but not permit a participant to drop group health plan coverage altogether. The added bonus here is that, if a plan sponsor permits this relief, an employee that newly elects coverage under a HCFSA or DCFSA on March 1, 2021 (for example) may use those funds to reimburse claims incurred back to January 1, 2021 (for a calendar year plan).

To take advantage of each of the permissible changes above, the HCFSA or DCFSA plans must be amended no later than the last day of the first calendar year beginning after the end of the plan year in which the amendment is effective. For example, calendar year 2020 plan amendments must be adopted on or before December 31, 2021. The HCFSA and DCFSA must operate consistently with the terms of the amendment retroactive to its effective date.


If you have any questions or would like more information on the issues discussed in this LawFlash, please contact any of the following Morgan Lewis lawyers:

Lisa Barton

Sage Fattahian
Lindsay Goodman

New York
Craig Bitman

Robert Abramowitz
Amy Pocino Kelly

John Ferreira
R. Randall Tracht

Washington, DC
Althea Day
Allison Fepelstein
Gregory Needles
Jonathan Zimmerman