|November 7, 2013|
Previously published on November 5, 2013
As a Halloween treat, the IRS issued a notice (Notice 2013-71) modifying the “use it or lose it” rule for health flexible spending arrangements (FSAs). This new guidance permits an employer to amend its FSA to allow up to $500 in unused amounts to be carried over and applied toward medical expenses incurred during the following plan year. There is a tradeoff to using this new carryover: a FSA cannot provide for both the new carryover and a “grace period”. This carryover provision is available to employers as early as the 2013 plan year.
Change to “Use It or Lose It Rule”
The “use it or lose it” rule is a fundamental feature of health FSAs. This rule provides that any unused amounts remaining in a FSA at the end of a plan year, or by the end of a 2-1/2-month “grace period”, must be forfeited and cannot be carried over for use in a subsequent plan year.
This new guidance changes the “use it or lose it” rule to permit an employer, at its option, to amend its plan to allow participants to carry over unused health FSA amounts of up $500 to the immediately following plan year. This carryover of up to $500 may be used to pay or reimburse medical expenses incurred at any time during this following plan year. Although the maximum unused amount allowed to be carried over in any plan year is $500, an employer may elect to allow a lesser amount (or not allow any carryover at all). The $500 carryover is not counted against the $2,500 limit on salary reductions. Thus, a participant who carries over $500 from the previous year and who elects to contribute $2,500 for the current plan year, has a potential reimbursement amount of $3,000.
To use this carryover provision, the plan cannot also include a “grace period". The “grace period” provision allows FSA participants to use amounts remaining from the previous year to pay qualified medical expenses incurred during a 2-1/2 month period following the end of that plan year. This new guidance specifically states that a plan adopting the carryover provision cannot also provide a grace period in that following plan year. Thus, an employer that wishes to use this carryover provision may need to amend its plan to remove any existing grace period feature.
To utilize this new carryover option, an employer must amend cafeteria plan documents on or before the last day of the plan year from which amounts may be carried over. The amendment may be effective retroactively to the first day of that plan year, provided that participants are notified of the change. The guidance contains a special transitional rule allowing the carryover provisions to be effective for the 2013 plan year if the plan is amended at any time on or before the last day of the plan year that begins in 2014. If the plan must be amended to eliminate the grace period, the amendment must be adopted no later than the end of the plan year from which amounts may be carried over.
Other Guidance - Changing Mid-Year Elections for Non-Calendar Year Plans
In addition to the modification of the “use it or lose it” rule, the guidance offers clarification of transition relief available to participants in non-calendar year cafeteria plans who may need to modify their health plan elections as a result of the Affordable Care Act. The transition relief was initially included in the proposed regulations addressing employer shared responsibility penalty provisions. See "IRS Issues Proposed Regulations on the Employer Penalty under the Affordable Care Act." The transition relief permitted an applicable large employer to amend its cafeteria plan documents to allow employees, during the plan year beginning in 2013, to revoke or change their elections prospectively or to make a prospective election for health care coverage, whether or not the employee incurred a qualified “change in status”.
The IRS notice extends this transition relief to all employers, and not just applicable large employers subject to the Affordable Care Act’s employer shared responsibility mandate. Plan amendments must be adopted no later than December 31, 2014 to implement this transition rule.