IRS Notice 2020-33 Increases Health FSA Carryover Limit and Clarifies ICHRA Guidance

In response to a 2019 executive order directing an increase in the allowable health FSA carryover amounts, IRS Notice 2020-33 increased the maximum $500 carryover amount to an amount equal to 20 percent of the maximum health FSA salary reduction contribution for the plan year. For plan years beginning in 2020, the maximum health FSA salary reduction is $2,750, which means the maximum amount health FSA participants may carry over for a plan year beginning in 2020 is $550.

Employers must adopt a cafeteria plan amendment to allow for this increased health FSA carryover limit. Generally, such an amendment must be adopted on or before the last day of the plan year from which amounts may be carried over. However, IRS Notice 2020-29 permits employers to adopt the plan amendment on or before December 31, 2021, and to be effective retroactive to January 1, 2020, if all eligible employees are informed of the changes to the plan.

Individuals who, during 2020, want to increase their health FSA contributions, or begin making health FSA contributions, as a result of the increased carryover amount may do so in accordance with IRS Notice 2020-29. While only future salary may be reduced under the revised election, amounts contributed after the revised election may be used for any medical expenses incurred during the first plan year that begins on or after January 1, 2020.

Finally, the IRS clarified that for purposes of determining when a premium for health insurance is incurred such that it can be reimbursed as a medical care expense through an individual coverage health reimbursement arrangement (ICHRA), the plan may treat the expense as incurred on (1) the first day of each month of coverage on a pro rata basis, (2) the first day of the period of coverage, or (3) the date the premium is paid. Accordingly, an ICHRA with a calendar year plan year may immediately reimburse a substantiated premium for health insurance coverage that begins on January 1 of that plan year, even if the covered individual paid the premium for the coverage prior to the first day of the plan year.

Treasury and IRS intend to revise the proposed cafeteria plan regulations to reflect this guidance, but taxpayers may rely on IRS Notice 2020-33 until such regulations are published.