Following the Consolidated Appropriations Act of 2020 (CAA), the American Rescue Plan Act of 2021 (ARPA) was signed into law on March 11, 2021. ARPA provides for a one-year increase to the dependent care FSA limit. For calendar year 2021 only, the dependent care FSA limit increases to $10,500 ($5,250 for married individuals filing separately). ARPA also includes full (100%) COBRA subsidies for April through September for employees and family members who lost coverage because of involuntary termination of employment or reduction of hours.
The House passed ARPA with a provision to provide 85% COBRA subsidies from April through September.
The Senate passed its amended version of ARPA with two major employee benefits-related enhancements to the House version:
- The Senate version increased the COBRA subsidies from 85% to being fully subsidized (100%).
- The Senate version increased the dependent care FSA limit to $10,500($5,250 for married individuals filings separately) for calendar year 2021.
Dependent Care FSA Increase to $10,500 for 2021
Despite not being addressed at all in the original House version of the bill, the Senate version of ARPA surprised the employee benefits world with an increase to the dependent care FSA limit for calendar year 2021.
The Standard $5,000 Dependent Care FSA Limit
Employees can contribute up to $5,000 to the dependent care FSA each calendar year. The limit is reduced to $2,500 for married individuals filing separately.
Congress did not index the $5,000 limit to inflation when it established the cap in 1986. Internal Revenue Code §129 simply fixes the contribution limit at $5,000 per calendar year. As a result, the dependent care FSA limit remained constant at $5,000 for 35 years. Using the Bureau of Labor Statistics’ standard CPI inflation calculator, $5,000 in 1986 is the equivalent to $11,933 in 2021.
The IRS has confirmed on multiple occasions that only an act of Congress can modify that $5,000 statutory limit, including in a 2016 letter responding to First Lady Michelle Obama’s inquiry as to whether the IRS could increase the limit using its regulatory authority.
ARPA represents the first time since 1986 that Congress has acted to increase the dependent care FSA limit.
ARPA provides that the dependent care FSA limit for calendar year 2021 will be $10,500.
As with the standard rules, the limit is reduced to half of that amount, or $5,250, for married individuals filing separately.
ARPA automatically sunsets the increased dependent care FSA limit at the end of 2021. Therefore, absent additional Congressional action, the dependent care FSA limit will revert to $5,000 for the 2022 calendar year ($2,500 for married individuals filing separately).
If an employer wishes to allow this temporary increase and the employer’s current dependent care FSA plan contains a specific dollar limit (e.g., $5,000) the employer must amend its dependent care FSA plan no later than the last day of the plan year in which the amendment is effective (December 31, 2021 for calendar year plans).
Importance of CAA FSA Election Change Relief
Under the Section 125 rules, once a participant has made an election for a plan year, that election is irrevocable during the plan year unless the participant experiences a change in status. The CAA provides that for plan years ending in 2021, employers may amend their Section 125 cafeteria plan to permit participants to prospectively change their Section 125 elections relating to health FSAs and dependent care FSAs without experiencing a permitted election change event. This includes any mid-year election to enroll in, increase, decrease, or revoke the FSA election.
Employers that have adopted the relief will be able to permit employees to increase their dependent care FSA elections to reflect the increased limit regardless of whether the employee experiences a permitted election change event.
Alternatively, it is likely that the mid-year increase to the dependent care FSA contribution limit qualifies as a significant improvement of a benefit package option under the existing permitted election change event rules. Under that event, employees could enroll or increase an existing election in the dependent care FSA within the cafeteria plan’s specified timeframe (generally 30 days) even under the standard election change rules set forth in Treas. Reg. §1.125-4.
Non-Calendar Plan Year Dependent Care FSAs
Another quirk of the new 2021 calendar year limit increase is the complexity of applying it to a dependent care FSA that does not have a calendar plan year.
Employers sponsoring a non-calendar plan year dependent care FSA are already familiar with the complications that can arise from having a contribution limit tied to the calendar year. As with the standard §129 limit, the ARPA increase to 2021 appears to apply only to the 2021 calendar year. In other words, regardless of the cafeteria plan year, the $10,500 limit is available only for calendar year 2021.
Fortunately, because of the CAA election change relief provisions and existing permitted election change events described above, employers should be able to permit employees to change their dependent care FSA election to coordinate with the different 2021 calendar year limit.
Non-Calendar Plan Year Example:
- Stephanie’s employer has a July 1 – June 30 dependent care FSA plan year.
- She elected to contribute $5,000 to the dependent care FSA for the current plan year running from July 1, 2020 through June 30, 2021.
- Her employer has adopted the CAA relaxed election change relief for plan years ending in 2021.
- The employer adopts the 2021 increased $10,500 dependent care FSA limit as of April 2021.
Non-Calendar Plan Year Result:
- For the current plan year running July 1, 2020 – June 30, 2021, Stephanie contributes $1,250 ($208.33 per semi-monthly payroll) to the dependent care FSA in calendar year 2021 (January – March 2021) prior to the increased $10,500 limit being made available under the plan.
- Stephanie takes advantage of the CAA FSA election change relief offered by the employer to increase her dependent care FSA election as of April 2021.
- She increases this election from $208.33 to $513.89 per semi-monthly pay period for the remainder of the plan year (April 2021 – June 2021).
- Stephanie then elects to contribute $513.89 per semi-monthly pay period at open enrollment for the dependent care FSA plan year beginning July 1, 2021, so she will reach $10,500 over the full calendar year 2021.
What Happens at the End of 2021?
- Although not clear yet, the IRS may provide that the cafeteria plan can automatically reduce employees’ elections back to $208.33 per pay period as of January 2022 to reflect the lower $5,000 contribution limit that will apply in calendar year 2022.
- Alternatively, the employer can likely permit employees to change their elections back to $208.33 per pay period as of January 2022 based on the significant curtailment of coverage permitted election change event.
- As a second alternative, the employer could reduce employees’ dependent care election limit at open enrollment for the plan year beginning July 1, 2022 to ensure that 2022 calendar year contributions do not exceed $5,000.
Have more questions on how to communicate these changes to your employees? Existing clients can contact their client experience manager to leverage our system communication tools. Not a WBD client? No problem, contact us today to see how we can help.