IRS Eases Rules on Flexible-Spending Accounts During Pandemic

Summary

WSJ Your Money Briefing

Episode Summary: IRS Eases Rules on Flexible-Spending Accounts During Pandemic

Date: May 14, 2020
Host: J.R. Whalen, Wall Street Journal
Guest: Laura Saunders, WSJ Tax Reporter

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Episode Overview

This episode focuses on the IRS’s temporary rule changes for Flexible Spending Accounts (FSAs), particularly Dependent Care FSAs, in response to the COVID-19 pandemic. With widespread school and childcare closures, many Americans have found themselves unable to use funds allocated for dependent care. The IRS aims to help by allowing more mid-year flexibility for FSA contributions, offering a rare opportunity to adjust or stop contributions.

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Key Discussion Points and Insights

1. Context: Pandemic Disrupts Dependent Care Needs

• With schools and summer camps closed due to the pandemic, families find their pre-tax FSA contributions for dependent care building up, often with no eligible expenses to withdraw them for.
• “The money going into FSAs through automatic contributions could be more useful elsewhere.” (B, 00:20)

2. IRS Rule Changes: Allowing Mid-Year Adjustments

• The IRS now permits participants to alter their Dependent Care FSA elections mid-year—something previously only allowed following major life events (e.g., birth, death, divorce).
  • Participants can suspend, decrease, or increase contributions, subject to employer adoption of these changes.
• “Now they're saying that you can go back into the account and change your elections and either turn off the election, stop the money you're putting in, or you can make it more or you can make it less.” (C, 01:40)
• “The IRS is giving the company the ability to allow workers to do this.” (C, 01:40)

3. Limitations: Can You Withdraw the Money?

• Money already contributed to an FSA generally cannot be withdrawn for non-eligible expenses, even under the new rules.
  • “Once you put money in, you can't take it out, except for reimbursable eligible expenses.” (C, 02:57)
• The real benefit is halting future contributions to prevent further unusable accumulation.
  • “At least you can stop it from getting to be more.” (C, 03:19)

4. Tax Advantage of FSAs

• Money contributed is pre-tax—meaning no income or payroll taxes are deducted.
  • “It's pre tax in a really good way...no income taxes and no payroll taxes either for the employee or the employer. And that's...a pretty good deal because payroll taxes are up over 12%.” (C, 03:29)

5. Rare Opportunity and Employer Involvement

• These mid-year changes are a departure from standard FSA policies and underscore the IRS’s responsiveness to the current crisis.
  • “Opportunities to make changes don't come around very often.” (B, 03:45)
  • “IRS is doing what it can to, you know, give people options.” (C, 03:49)
• However, changes require employer action—employers must adopt the new flexibility into their plans, so employees should consult their HR departments.
  • “It's a two step process...the employer has to adopt these changes into its own plan. They are not required to do that.” (C, 04:41)

6. Eligible Expenses and Dependents

• FSAs primarily cover care for children under 13, but can also be used for elder dependents or disabled children unable to care for themselves.
  • “It could also be used for a disabled child over the age of 13, but who can't care for himself or herself.” (C, 04:06)
  • “With dependent care FSAs, they apply to a lot of expenses for children under 13, if those expenses allow the parents to work.” (C, 05:13)

7. Similar Flexibility for Health Care FSAs

• Health care FSAs also receive temporary mid-year flexibility.
  • “Health care FSAs also have new flexibility that's a little different from what's going on with dependent care FSAs.” (C, 05:49)
  • Also applies to employer health plan elections—employees can change coverage without a life event this year.

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Notable Quotes & Memorable Moments

• On the unprecedented change:
  “This is not what the law was set up for. But we're in the middle of a crisis and the IRS is doing what it can to, you know, give people options.”
  — Laura Saunders (03:49)

• On the dual IRS/employer process:
  “It's a two step process. It's what the law allows and the IRS interprets. But then the employer has to adopt these changes into its own plan. They are not required to do that.”
  — Laura Saunders (04:41)

• On the perennial risk of losing FSA funds:
  “They could. And that may be. It may be hard to get it back, but at least you can stop it from getting to be more.”
  — Laura Saunders (03:19)

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Important Timestamps

• 00:20 – Episode introduction and pandemic context for FSAs
• 01:40 – Explanation of new IRS flexibility and how it works
• 02:57 – Limitation on withdrawing FSA funds for non-eligible expenses
• 03:29 – Breakdown of tax benefits for FSAs
• 04:06 – What expenses and dependents are eligible
• 04:41 – Employer adoption requirement explained
• 05:13 – Review of rules relating to the age and type of dependents
• 05:49 – Mention of similar flexibility for health care FSAs and health plans

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Key Takeaways

• The IRS has granted rare flexibility for mid-year changes to FSA contributions to address pandemic-related changes in dependent care needs.
• These changes depend on employer adoption; employees should check with their HR departments.
• Participants cannot retroactively withdraw unused funds except for eligible expenses, but can stop or decrease future contributions to avoid further accumulation.
• The new rules also extend—though with differences—to health care FSAs and health insurance plan selections.

This episode provides concise, actionable advice for anyone managing pre-tax benefits in 2020, especially those whose dependent care needs have changed due to the pandemic.

Transcript

[A]

This episode is brought to you by Charles Schwab. Decisions made in Washington can affect your portfolio every day. Washington Wise from Charles Schwab is an original podcast that unpacks the stories making news in Washington. [e-mail] Washingtonwise.

[B]

Here's your money briefing for Thursday, May 14th. I'm J.R. whalen for the Wall Street Journal. Millions of Americans set aside money for programs like daycare and summer camp using a pre tax savings plan called a flexible spending account or fsa. But now that schools are closed and the kids are staying home, the money going into FSAs through automatic contributions could be more useful elsewhere.

[C]

Yes, the IRS is doing what it can within the letter of the law to give people a lot more flexibility. If they thought they were going to be paying for summer camp this summer or after school care and those things have gone away, they may have money piling up in those accounts and they were just going to keep putting money in if they hadn't gotten these new rules, this new flexibility from the irs.

[B]

That's Wall Street Journal tax reporter Laura Saunders coming up. She'll explain what people can and cannot do with the money in their fsa. Americans who are making automatic contributions to flexible spending accounts or FSAs for their kids or older depend are getting some relief from the irs. Wall Street Journal tax reporter Laura Saunders is with us with details. So, Laura, what are the changes the IRS is allowing regarding dependent care FSAs?

[C]

What they're doing is they're providing a lot more flexibility in general, when you elect to put money into a dependent care fsa, you make that decision before the beginning of the year and then you can't change it during the year unless something really big happens like a divorce or a death or a birth or what. Now they're saying that you can go back into the account and change your elections and either turn off the election, stop the money you're putting in, or you can make it more or you can make it less. And that's if the company also allows you to do it. But the IRS is giving the company the ability to allow workers to do this.

[B]

So the IRS is recognizing that people's lives have been really thrown into upheaval.

[C]

Yes, the IRS is doing what it can within the letter of the law to give people a lot more flexibility. If they thought they were going to be paying for summer camp this summer or after school care and those things have gone away, they may have money piling up in those accounts and they they were just going to keep putting money in if they hadn't gotten this new, these new rules, this new flexibility from the irs.

[B]

So in a year like the one that we're in, can people withdraw the money?

[C]

That's not entirely clear, but apparently within the letter of the law, once you put money in, you can't take it out, except for reimbursable eligible expenses. And so what this allows you to do is to lower the contribution or to turn it off or to raise it if you need to do that.

[B]

So there's still a risk of losing the money that's in there.

[C]

They could. And that may be. It may be hard to get it back, but at least you can stop it from getting to be more.

[B]

Is any money put into the FSA taxable?

[C]

No, it's pre tax money and it's pre tax in a really good way. It comes out with no income taxes and no payroll taxes either for the employee or the employer. And that's a pretty good deal because payroll taxes are up over 12%.

[B]

It seems like opportunities to make changes don't come around very often.

[C]

No, they really don't. This is not what the law was set up for. But we're in the middle of a crisis and the IRS is doing what it can to, you know, give people options.

[B]

Now, do the IRS say that only people who have money set aside for things like daycare or summer camp are eligible to make changes?

[C]

Well, it's mainly used for daycare, summer camp, and after school care. But remember that the dollars in these accounts can be used for care for elderly dependents, like if your mother is your dependent. It could also be used for a disabled child over the age of 13, but who can't care for himself or herself. There are a range of options. It's just that mostly it has gone for the care of children under age 13.

[B]

Now, an employer has to take some steps in order for this flexibility to be available to the employee.

[C]

It's a two step process. It's what the law allows and the IRS interprets. But then the employer has to adopt these changes into its own plan. They are not required to do that. So people who have questions should talk to their employers. But the experts we talk to think that most employers will adopt these changes pretty quickly.

[B]

Now, for people who might not be familiar with how dependent care FSAs work, the rules are kind of particular with respect to the ages of people the money would be spent on.

[C]

With dependent care FSAs, they apply to a lot of expenses for children under 13, if those expenses allow the parents to work, that's the idea of it. And if the child is 13 or older, maybe a mother, a father, a disabled child, if those people cannot take care of themselves, then dollars can go into the account to be used for their care in a way that allows the responsible person, the parent or whatever to work.

[B]

And what other types of changes has the IRS made to other kinds of FSAs?

[C]

Health care FSAs also have new flexibility that's a little different from what's going on with dependent care FSAs. So people should talk to their HR departments about that. And the other thing the IRS did was to give new flexibility on health coverage. Usually you have to set it, you know, before the year begins. And you can't go back in unless there's a life change event like a death or a birth or something. But people have new freedom this year to move into plans or out of plans or to change their elections inside the plans.

[B]

All right, that's Wall Street Journal tax reporter Laura Saunders. Laura, thanks for coming on the show.

[C]

Thanks so much for having me.

[B]

And that's your Money briefing. I'm J.R. whalen for the Wall Street Journal.

[A]

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