|November 13, 2013|
Previously published on November 8, 2013
Health flexible spending accounts ("Health FSAs") are a popular component of cafeteria plans that permit salary reduction contributions and flex credits from which certain medical expenses may be reimbursed on a pre-tax basis. In this client alert, we summarize a new plan design option with respect to Health FSA amounts which remain unspent at the end of a plan year.
Under existing law, which includes proposed Treasury regulations under section 125 of the Internal Revenue Code (the "Code"), an election to make salary reduction contributions to a cafeteria plan is generally irrevocable with respect to the plan year for which it is made. Unspent amounts must be forfeited at the end of such plan year with certain limited exceptions. One exception permits expenses incurred during the prior plan year to be submitted for reimbursement during a "run-out" period in the subsequent plan year. Another exception permits a cafeteria plan to offer a "grace period" in the first two and a half months of the subsequent plan year. Expenses incurred during the grace period may be reimbursed using any unspent amounts from the prior plan year. After the end of the grace period, any amounts still unspent must be forfeited.
On October 31, 2013 the IRS issued Notice 2013-71 which includes a new exception for the Health FSA component of a cafeteria plan. A cafeteria plan may now be amended to permit up to $500 of unspent Health FSA amounts to be carried over to a subsequent plan year. The carryover is then available to pay for expenses incurred at any time during the subsequent plan year. The carryover does not reduce the annual election available to the employee for the subsequent plan year. Thus, if an employee contributes $2,500 to a Health FSA in the 2014 plan year and has $800 unspent as of the end of the 2014 plan year, such employee may elect to contribute $2,500 for the 2015 plan year and will have a total of $3,000 ($2,500 plus $500 carryover) available for reimbursement of medical expenses incurred in the 2015 plan year (less any expenses incurred during the run-out period for the 2014 plan year, if applicable).
This exception may not be used in conjunction with a grace period. Employers should therefore take into account current patterns of reimbursements and forfeitures when deciding which design option is most appropriate for their plan. Specific concerns for employers whose plans currently provide a grace period include fiduciary and contractual obligations with respect to participant's existing Health FSA elections. Employers whose plans currently provide a grace period will also need to consider the timing of plan amendments required in order to adopt a carryover feature. While the Notice offers employers flexibility in the timing of any amendment with respect to the 2013 plan year, legal constraints outside the Code may limit this flexibility.
Notably, IRS Notice 2013-71 leaves a number of questions unaddressed. The interaction of the carryover with the grace period and the run-out period relies, in part, upon the proposed cafeteria plan regulations issued in 2007 which have yet to be finalized. Also, the Notice does not address the specific application of the carryover to a cafeteria plan that provides for employer flex credits in addition to salary reduction contributions. Finally, it does not address the interaction of a carryover which is available only for Health FSA amounts with the continuing availability of a grace period with respect to other components of a cafeteria plan such as a dependent care flexible spending account or "DCAP".
Because of these uncertainties and because facts and circumstances vary greatly, employers should consult benefits counsel before amending a cafeteria plan to offer a carryover for unspent Health FSA amounts.