The coronavirus (COVID-19) outbreak has upended many aspects of our daily lives, including the need for dependent care. Employees who elected pre-tax salary deductions toward a dependent care flexible spending account (DC FSA) may be wondering what their options are for managing their DC FSA if their circumstances have changed. In this article we review frequently asked questions regarding the following:
- Changing DC FSA elections;
- Reimbursing expenses from a DC FSA if employees (or their spouse) experience a reduction in hours, are working from home, or are furloughed; and
- The use of DC FSA funds upon termination.
Change in DC FSA Elections
Normal rule: Employee pre-tax elections toward their DC FSAs cannot be changed unless a Section 125 “qualified life event” occurs (e.g. marriage, birth, death, etc.) or there is a change in the cost of coverage or a change in employment status.
1. Can employees change their DC FSA election due to COVID-19?
Technically, COVID-19 is not a “qualified life event” that would allow employees to change their DC FSA election. However, most plans permit employees to change their DC FSA elections if the cost of their dependent care changes or if their (or their spouse’s) work schedule changes. Thus, employees can change their elections if COVID-19 causes a change in dependent care costs or changes in work schedule. Some common scenarios are outlined below:
- Employees can revoke or decrease their election if their dependent care provider has closed due to COVID-19
- Employees can increase their election if their child’s school is closed and they now need to pay for daycare
- Employees can change their election if their normal dependent care provider has closed due to COVID-19 and a different provider is more expensive or less expensive
- Employees can revoke or decrease their election if they are now working from home and no longer need childcare services (and later increase their election if they later return to work and need childcare services then)
Further, the IRS released Notice 2020-29 on May 12, 2020, which gives employers the option to allow employees to prospectively revoke their election, make a new election, or increase/decrease an existing election for their DC FSA, even if a Section 125 “qualified life event” has not occurred. Employees will not automatically have these new rights to make mid-year changes, as employers have discretion to determine if mid-year elections will be allowed, when they will be allowed, how long they will be allowed, and the conditions under which they will be allowed.
For employers to allow for a mid-year change without a qualified life event, they must amend their Section 125 Cafeteria Plan documents accordingly and notify their employees of any changes. For more on the new IRS guidelines, see our blog article.
2. When do employees need to make their election change?
Normal rule: Generally, employees must change their DC FSA election within 30 days of the change event (e.g. change in work schedule or change in cost). Plans may allow employees a longer period to change their election, so employees should review their plan documents to determine how long they have to make an election change.
In addition, if employers will be allowing employees to change their election pursuant to IRS Notice 2020-29 (without a “qualified life event”), they should set a time period in which employees must make their election change. Employers have wide discretion on what time period and how long they will allow employees to change elections (as long as the elections are effective prospectively and are made prior to January 1, 2021).
3. Can employers allow employees to make an election, revoke their election or change their existing election even if a qualified life event has not occurred?
Yes, as stated above, employers now have the option to allow employees to revoke an election, make a new election, or change an existing election in accordance with IRS Notice 2020-29. The IRS Notice permits employers to allow employees to make prospective election changes during the 2020 calendar year, regardless of whether they experience a qualified life event.
4. What happens if employees have unused amounts at the end of the plan year?
Normal rule: Employees must forfeit any unused funds at the end of the plan year (or grace period, if applicable). Some plans have a grace period, whereby the plan allows employees up to 2 ½ additional months after the end of the plan year to incur new expenses.
The recently released IRS Notice 2020-29 (mentioned above) gives employers the option to implement an additional grace period for plans that end in 2020 (e.g. 2019 non-calendar year plans or 2019 calendar year plans with a grace period). Employers can allow employees to apply any unused DC FSA funds that remain at the end of the plan year to claims incurred through December 31, 2020. Employers who want to allow this must amend their Section 125 Cafeteria Plan documents accordingly and notify their employees of the plan change. For more on the new IRS guidelines, see our blog article.
Reimbursable Expenses: Working from Home, Reduction in Hours, and Furloughs
Only “employment-related” expenses are reimbursable through a DC FSA. Dependent care expenses are “employment related” if:
- They enable both the employee and the employee’s spouse to be “gainfully employed” or looking for “gainful employment;” and
- The expense is for the “care” of one or more “qualifying individuals” (e.g. child under the age of 13 or tax dependent family member).
Expenses are not automatically considered “employment related” just because they were incurred while an employee and their spouse were working; they must enable the employee and their spouse to work or actively search for work. Further, the determination of gainful employment is determined on a daily basis.
The “gainful employment” requirement for an employee and their spouse may become an issue during the COVID-19 outbreak when work schedules are changing. Below, we review some scenarios that may impact whether employees (or their spouse) are considered “gainfully employed” and the ability to reimburse DC FSA claims.
1. Can employees incur reimbursable expenses while they (or their spouse) are working from home?
Generally, yes. If the dependent care is necessary while an employee (and/or their spouse) are working from home, then these expenses are reimbursable because they enable the employee (and/or their spouse) to be gainfully employed.
2. Can employees incur reimbursable expenses if their (or their spouse’s) hours are reduced?
Yes, but only dependent care that allows the employee and their spouse to work are reimbursable. This means that expenses are only reimbursable for the days that an employee and their spouse are working (employees are considered working if they work at least 1 hour that day). For example, if Dave’s hours are reduced so that he now only works Monday through Wednesday, dependent care expenses are only reimbursable Monday through Wednesday.
The IRS provides an exception to this rule for employees who are required to pay for care on a periodic basis (such as monthly or weekly). If employees are required to pay on a periodic basis, employees can reimburse that entire amount from their DC FSA, even if it includes expenses for days the employee does not work. For example, Dave only works Monday through Wednesday, but his child’s day care provider requires him to pay on a weekly basis. Dave is permitted to reimburse the cost of the entire week of day care expenses.
3. Can employees continue participating in their DC FSA if they are furloughed?
Employees can continue participating in their DC FSA if it is permitted under the terms of the plan document. Employees should review the eligibility provisions of their DC FSA plan document to determine whether they can continue to participate while they are furloughed.
Employers are not required to allow employees to participate in their DC FSA during a leave of absence or a furlough. If employers do want to allow employees to continue coverage during the furlough, they should ensure their plan documents allow for this or amend their plan documents accordingly. In addition, employers who allow employees to continue coverage should determine how employee contributions will be made during the furlough.
4. Can employees revoke their DC FSA election if they are furloughed?
Yes, employees can revoke their DC FSA election due to a furlough because it would be considered a “change in employment status” qualified life event. Employees may be able to make a DC FSA election once they return from their furlough (if their plan documents permit this).
5. Can employees incur reimbursable expenses while they are furloughed?
Generally, expenses incurred while a parent is not working are not reimbursable because they were not incurred to enable the employee (or their spouse) to be gainfully employed.
However, the IRS has allowed an exception to the “gainful employment” rule for short temporary absences of up to two consecutive weeks. This means that expenses can still be incurred during a short temporary absence, even if the employee is not working during that time.
The IRS originally devised this exception for short absences such as a vacation or a minor illness, and not for longer absences, such as a family and medical leave (FMLA) that lasts longer than 2 weeks. Thus, under this exception, an employee can incur reimbursable expenses during a furlough only if the furlough is for less than 2 weeks.
An employee could also theoretically incur reimbursable expenses during a furlough if the dependent care enables them to look for gainful employment. Employees should consult with their tax advisor before using this approach.
6. Can employees incur reimbursable expenses from their DC FSA if their spouse has been furloughed?
The expenses must enable both the employee and their spouse to be “gainfully employed” or looking for gainful employment. Therefore, the discussion in the prior section applies to this scenario, as well.
7. How can employees continue to pay for the DC FSA payments while they are furloughed?
Payroll deductions for DC FSA contributions are stopped during the furlough period because employees no longer receive a paycheck. Employers can give employees the option of pre-paying the contributions or making catch up contributions once they return from the furlough. If a furlough is for an indefinite period, the latter approach would be the more feasible option. For catch-up contributions, the employer would advance DC FSA contributions with the understanding that employees will pay them back once they return.
DC FSAs and Terminations
1. Can employees incur reimbursable expenses from their DC FSA if their spouse has been laid off?
Expenses must enable both the employee and spouse to be gainfully employed. Therefore, the expenses for dependent care will not be reimbursable if the employee’s spouse is laid off, unless the dependent care enables the employee’s spouse to look for gainful employment.
2. If an employee is terminated, do they lose access to their unused DC FSA amounts?
If at the time an employee is terminated they have remaining funds (they contributed more to their DC FSA than they reimbursed), they may be able to submit claims incurred prior to the date of termination during a “run-out period.” Run-out periods are usually 30, 60, or 90 days. Not all plans have run-out periods, so terminated employees should review their plan documents to determine whether their plan has one.
In addition, some plans have an optional “spend down” provision, which allows employees to continue incurring and reimbursing expenses for a certain time period (e.g. until their unused funds are spent or until the end of the plan year). Again, not all plans have spend down provisions, and those that do may have different time periods for which employees can continue to incur claims after being terminated. Terminated employees should review their plan documents to determine whether their plan has a spend down provision and how long it lasts.
Employees forfeit any funds they have remaining at the end of their run-out period or at the end of the spend down period.
3. Can employees incur new expenses after they are terminated?
Employees can only incur new reimbursable expenses after they are terminated if:
- At the time of their termination, they have contributed more to the DC FSA than they have been reimbursed for (i.e. they have unused funds); and
- Their DC FSA has a spend-down provision, which allows them to incur new expenses after their termination for a specified period (e.g. until the end of the plan year).
Employees should review their plan documents to determine whether their DC FSA has a spend down provision.
Conclusion
- Employees can change their DC FSA election if they experience a qualified life event, a change in cost, or a change in employment status.
- Only dependent care expenses that enable an employee (and their spouse) to be gainfully employed or to seek gainful employment are reimbursable through a DC FSA.
- Employees may have additional time to use remaining DC FSA funds after they are terminated if their plan has a spend down provision.
- IRS Notice 2020-29 allows employers additional flexibility to allow for mid-year DC FSA election changes and to implement a grace period for unused funds during the 2020 calendar year.
Additional Resources
- IRS Notice 2020-29
- Employers Can Now Permit Mid-Year Election Changes and Claim Extensions due to COVID-19
The information and materials on this blog are provided for informational purposes only and are not intended to constitute legal or tax advice. Information provided in this blog may not reflect the most current legal developments and may vary by jurisdiction. The content on this blog is for general informational purposes only and does not apply to any particular facts or circumstances. The use of this blog does not in any way establish an attorney-client relationship, nor should any such relationship be implied, and the contents do not constitute legal or tax advice. If you require legal or tax advice, please consult with a licensed attorney or tax professional in your jurisdiction. The contributing authors expressly disclaim all liability to any persons or entities with respect to any action or inaction based on the contents of this blog.
