IRS Guidance Modifies the Use-it or Lose-it Rule and Permits a Status Change Event for Marketplace Enrollment
One of the requirements of an Internal Revenue Code Section 125 cafeteria plan is that there can be no deferral of compensation from one plan year to the other. The only exception to this when there is a health savings account component plan or a 401k component plan tied to the cafeteria plan. For this reason, flexible spending accounts have been subject to what has become known as the ‘use-it or lose-it’ rule wherein any unused account balance remaining at the end of the plan year is lost. For years, Congress has toyed with the idea of modifying this use it or lose it rule. To that end, on October 31, 2013, the Internal Revenue Service issued Notice 2013-71. This IRS guidance modifies the use-it or lose-it rule to allow up to $500 of unused dollars to be carried forward and used in the next plan year.
One of the requirements for this carry-forward is that the health FSA cannot include a grace period during which claims can be incurred. A grace period is distinguished from a run-out period in that during a grace period, claims can be incurred and reimbursed from prior year funds. In a run-out period, expenses incurred in the prior year can be reimbursed with funds collected in the prior plan year.
This new carry-forward provision allows up to $500 of unused funds to be carried forward and used anytime in the succeeding plan year.
Notably, the amount carried-forward does not reduce the salary reduction cap, currently $2,500, imposed on FSAs.
A plan wishing to avail itself of the carry-forward feature would have to be amended to terminate a grace period provision, if any; and would have to be further amended to provide for the carry forward. The plan can, but is not required to, allow the carry forward, and the amount carried forward can be any amount up to $500. The carry-forward feature must be available to all FSA plan participants.
According to this guidance, the plan must be amended prior to the end of the plan year to which the amendment applies, and the change must be made retroactive to the beginning of the plan year. Further, participants must be notified about the change. The Notice provides that an FSA plan commencing in 2013 can be amended in accordance with this guidance. A plan may be amended anytime prior to the end of the 2014 plan year, retroactive to the beginning of the 2013 plan year, as long as all of the conditions are satisfied.
In assessing whether to adopt the carry-forward feature, it is important to remember that a general purpose FSA causes an individual to be HSA-ineligible.
Status Change Event – Marketplace Enrollment
The Notice issued also clarifies previously issued guidance specific to status change events. As a result of the Affordable Care Act, a cafeteria plan can be amended to allow a one-time status change event allowing individuals to revoke an existing health plan election in order to obtain coverage through the Marketplace. The plan can be amended to allow a person to change a salary reduction in order to commence participation in the employer’s plan. This assumes the employer’s health plan will allow such a change. Or, the Section 125 plan can be amended to allow both status change events.
This is a one-time opportunity allowing a non-calendar year cafeteria plan to permit a status change in concert with the marketplace initial enrollment period (see Individual Shared Responsibility – Transition Relief in CBIZ HRB, Guidance and Updates, 9/11/13). This provision applies to plans of any size, not just those subject to employer-shared responsibility provision.