American Rescue Plan Act: Impact on employee benefits

The American Rescue Plan Act (ARPA), signed into law by President Biden on March 11, 2021, includes provisions that will significantly impact plan sponsors and administrators of health and cafeteria plans. The ARPA also impacts pension plan funding requirements and executive compensation deductions available to employers. These provisions and their potential impact on plan sponsors, plan administrators and employers are discussed in more detail below.

COBRA subsidy

The ARPA will require employers to implement new operational measures in the administration of COBRA benefits over the next six months. The statute requires employers to provide a full subsidy for individuals who qualify for continued health coverage under COBRA (or state mini-COBRA laws) on account of an involuntary termination of employment or a reduction of hours. It appears that individuals who voluntarily reduce their hours will qualify for the subsidy as well.

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The subsidy will apply for the period beginning on April 1, 2021 and ending on September 30, 2021. However, if an individual becomes eligible for Medicare or another group health plan (including a spouse’s employer-sponsored health plan), the subsidy will end, effective as of the first day of the next month. Individuals are required to notify the plan if they become eligible for such coverage.

Employers can recover the amounts that they expend on the ARPA COBRA subsidy by claiming tax credits against the 1.45% employment tax they pay for hospital insurance. The tax credits are refundable, so if the subsidies exceed the amount that an employer pays in employment taxes for hospital insurance, the employer will receive those excess amounts in cash payments.

Employers must issue a special notice to individuals eligible for a subsidy informing them of the availability of premium assistance. A second notice, informing them that the subsidy will end must be provided within the 30-day window ending on September 15, shortly before the subsidy expires. The notices must meet specific requirements, and the regulating agencies will issue model notices to address these requirements no later than April 10, 2021.

Additional COBRA election opportunities

Plans also must provide additional COBRA election opportunities to two types of individuals: (1) individuals who would be eligible for a subsidy, but for the fact that they do not have a COBRA election in effect on April 1, 2021; and (2) individuals who elected, but discontinued their COBRA coverage before April 1, 2021.

The statute does not limit the second group to individuals who are eligible for the subsidy, but could extend, for example, to individuals who experience a “second qualifying event”, such as former spouses who lost their coverage on account of divorce, or dependent children who aged out of a parent’s plan, if they discontinued their COBRA coverage before April 1, 2021.

Additional guidance may address whether the new election opportunity will extend more broadly or whether it will be read in the context of the statute to apply only to those eligible for subsidies.

Employers need to notify eligible individuals of this second COBRA election opportunity no later than May 31, 2021. To meet this notice requirement, employers may wish to start identifying the population of individuals who will be entitled to receive the notice. It will clearly include employees whose qualifying event for COBRA coverage was an involuntary termination of employment (or involuntary reduction of hours) within the past 18 months.

Further guidance may clarify the extent, if any, to which this list needs to be expanded to include individuals with a second qualifying event. If so, employers may need to look back 36 months from April 1, 2021 to identify some individuals and notify them of their right to an additional COBRA election period. As noted, it may reach those who have voluntarily reduced their hours and who have discontinued COBRA coverage (without qualifying for a subsidy).

Enhanced enrollment options

The statute also permits employers to allow individuals eligible for a subsidy to switch their medical coverage to a plan that is no more expensive than the plan in which they are currently enrolled; however, given that the subsidy will cover the full cost of coverage for up to six months, it is unlikely that employers will offer or that, if offered, individuals will elect a lower-cost option.

Dependent care Flexible Spending Account limit

The ARPA includes a provision that increases the amount that may be excluded as taxable income for dependent care flexible spending accounts (DCFSAs) in 2021 from $5,000 to $10,500 for unmarried individuals and individuals filing a joint return, and from $2,500 to $5,250 for married individuals filing separate returns. This relief appears to account for the increased carryover and extended grace period provisions permitted by the Consolidated Appropriations Act (CAA).

Specifically, the CAA permits DCFSAs to expand the grace period that allows participants to incur eligible expenses following the end of a plan year from 2-1/2 months to 12 months. The CAA also allows DCFSAs to incorporate a carryover provision so that employees may use any unused funds that remain in their account at the end of the plan year in 2020 or 2021 in the following plan year. The carryover provision was not previously permitted for DCFSAs and both the extended grace period and enhanced carryover provision apply only to plan years ending in 2020 and 2021.

If a DCFSA implements the extended grace period or increased carryover provisions permitted by the CAA, an eligible participant could have up to $10,000 credited to his or her DCFSA account in 2021 ($5,000 carried over from 2020 and $5,000 contributed in 2021). Absent the ARPA relief, the tax-favored status of reimbursements for eligible expenses from the DCFSA would be limited to $5,000. The ARPA mitigates this issue in 2021 by temporarily increasing the amount that may be excluded as taxable income for DCFSAs, permitting participants to take full advantage of the extended grace period or expanded carryover provisions in 2021, whichever they choose.

In response to this relief, some plan sponsors are considering whether to amend their DCFSA plans and allow an additional enrollment period to allow participants to contribute up to the increased limit for DCFSAs in 2021. This change would allow all plan participants to take advantage of the increased cap on tax-favored benefits in 2021, regardless of whether they had unused amounts in their account from 2020. However, plan sponsors should be mindful of a few factors that may affect their decisions.

• First, employers will need to consider how the increase in contributions will affect the DCFSA plan’s performance under the annual nondiscrimination tests. One of these tests measures whether highly-compensated employees (HCEs) disproportionately use benefits in the DCFSA compared to non-HCEs, and it is possible that HCEs will be the most likely to take advantage of the increased limit.
• Second, employers will want to advise employees to be careful in increasing their contributions to make sure that the benefits they receive remain tax-favored. For example, an employee who carries over $5,000 from 2020 and contributes $10,500 in 2021 will have $15,500 to use in 2021 or, if the employer permits, to carry over to 2022.
• Third, employers with non-calendar year plans may be limited in their ability to offer an additional enrollment period in 2021. They will also need to recognize that the $10,500 cap on the amount that may be excluded from income for federal tax purposes will apply based on the employee’s tax year, which will be the calendar year.
• Fourth, employers will need to consider whether any amendments to their plan documents will be required to account for the changes that they introduce. For a calendar year plan, an employer may adopt amendments on or before December 31, 2021, and apply them retroactively consistent with plan operation.

Funding requirements for pension plans

The ARPA provides significant funding changes that will provide relief to single-employer and multiemployer pension plans. The ARPA increases the period over which single-employer pension plans can amortize funding shortfalls, from a seven, to now a fifteen-year period. The statute also extends the interest rate stabilization period that applies to minimum funding through 2029, likely resulting in the reduction of an employer’s annual minimum funding obligations to its defined benefit pension plan throughout the next decade.

The ARPA provides separate funding relief provisions with respect to multiemployer pension plans, such as: (1) a plan sponsor’s ability to apply the same funding status that existed in the preceding plan year for plan years beginning during March 1, 2020 to February 28, 2021, and in the following plan year; (2) the extension of the funding rehabilitation periods for plans in endangered or critical status from 10 years to 15 years (and from 15 years to 20 years for seriously endangered plans) and; (3) the ability for plans that meet a solvency test to amortize certain gains and losses over a longer period of time. Additionally, the ARPA established a new fund administered by the Pension Benefit Guaranty Corporation to provide special financial assistance to multiemployer pension plans in critical or declining status.

Executive compensation – Covered employees

The ARPA includes an expanded definition of a “covered employee” for purposes of identifying the employees subject to the annual $1 million deduction limit on compensation under section 162(m) of the Internal Revenue Code. Currently, a covered employee includes the company’s CEO, CFO and the three highest-compensated employees. Beginning in 2027, covered employees will also include the company’s next five highest-compensated employees, resulting in at least 10 covered employees being subject to the $1 million deduction limit.