IRS Announces $500 Carryover Relief from Health FSA "Use-or-Lose" Rule (article)

IRS Announces $500 Carryover Relief from Health FSA "Use-or-Lose" Rule (article)

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The IRS has announced relief from the "use-or-lose" rule for health flexible spending arrangements (health FSAs) by allowing a new up-to-$500 carryover option for year-end balances. Effective for plan years starting in 2013, employers may amend their cafeteria plan documents to provide for this new option. The up-to-$500 carryover amount will not count toward the following year's $2,500 inflation-adjusted salary-reduction limit. Any unused amount above $500 will be forfeited, the IRS explained.

Comment: The IRS also clarified details relating to the FSA transition relief allowed for those employees currently switching to a Marketplace plan under the Patient Protection and Affordable Care Act (PPACA).

Background

A health FSA is pre-tax benefit that may be offered, at an employer's option, to employees under a Code Sec. 125 cafeteria plan. Employees who participate in an FSA are allowed to designate a portion of their salary to fund an account that may be used, pre-tax, to cover their qualified medical expenses. Starting in 2013, the PPACA limits each employee's salary reduction contributions to a health FSA to no more than $2,500 each year (adjusted for inflation for plan years beginning after 2013).

An employer that offers FSAs can allow each year's remaining account balance to be used for expenses incurred up until 2 ½ months into the next year (March 15 for calendar year plans). Account balances that remain unused at the end of the plan year (or beyond the 2 ½ month grace period, if applicable) are automatically forfeited (the "use-or-lose" rule).

Comment: FSAs are allowed only within the context of an employer-employee relationship and, only then, within the overall restrictions imposed under the Code Sec. 125 cafeteria plan rules.

New option

Notice 2013-71 now allows employers to amend their plans to provide an alternative to the 2 ½ month grace period. For plans with plan years that begin on or after January 1, 2013, an employer may amend a health FSA plan to allow up to $500 of unused amounts remaining in an employee's FSA at year end to be carried over into the next plan year. An employer must amend its plan before it can set forth the carryover option. Incorporation of the carryover option is optional, however, employers cannot offer both the grace period and the carryover at the same time.

An employer offering FSAs effectively now has three separate options:

  • Amend its plan to introduce the carryover of up to $500;
  • Keep or add the 2 ½ month grace period rule; or
  • Choose neither option for year-end account balances.

Comment: Although from IRS's perspective it will allow plan sponsors to switch to the up-to-$500 carryover option effective to plans starting anytime in 2013 (and make the amendment anytime before the end of the 2014 plan year), Notice 2013-71 notes that the ability to eliminate a grace period to adopt a $500 carryover option "may be subject to non-Code legal constraints."

The carryover of up to $500 may be used to pay or reimburse medical expenses under the health FSA incurred during the entire plan year to which it is carried over. The $500 amount does not count against or otherwise affect the indexed $2,500 salary reduction limit applicable to each plan year. However, the $500 amount is not cumulative from year to year; only a maximum of up to $500 may be carried forward during any future year.

Comment: The $2,500 annual limit is to be adjusted for inflation after 2013; the up-to-$500 carryover limit is not subject to an annual inflation adjustment. For 2014, the IRS has announced that the $2,500 amount remains at $2,500 because of rounding-down instructions under Code Sec. 125(i)(2)(B).


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IRS Announces $500 Carryover Relief from Health FSA "Use-or-Lose" Rule (article)The IRS has announced relief from the "use-or-lose" rule for health flexible spending arrangements (health FSAs) by allowing a new up-to-$500 carryover option for year-end balances. Effective for plan years starting in 2013, employers may amend their cafeteria plan documents to provide for this new option....2013-11-20T14:56:00-05:00The IRS has announced relief from the "use-or-lose" rule for health flexible spending arrangements (health FSAs) by allowing a new up-to-$500 carryover option for year-end balances. Effective for plan years starting in 2013, employers may amend their cafeteria plan documents to provide for this new option.