• IRS Allows $500 Exception to the Health FSA Use-It-Or-Lose-It Rule
  • November 7, 2013 | Author: Harris T. Booker
  • Law Firm: Barley Snyder - Lancaster Office
  • On October 31, 2013 the IRS issued Notice 2013-71, significantly modifying the longstanding general rule applicable to health care flexible spending accounts (FSAs) that any amounts in such accounts remaining unspent at year-end are forfeited, often referred to as the “use-it-or-lose-it” rule.  Under the new guidance, employers sponsoring such FSAs are now permitted, but not required, to modify their FSA arrangements to allow for a carry-forward from one year to the next, avoiding the forfeiture of up to $500 that remains unused at year-end.
     
    Previously, in 2005, the IRS had adopted a different sort of modification intended to soften the use-it-or-lose-it rule that allowed employers the option to adopt a 2½-month “grace period” after year-end during which an employee could continue to accrue medical expenses that could be applied against the prior year-end FSA balance. Under the Notice 2013-71 guidance, the primary limitation on an employer’s adoption of the new $500 carry-forward feature is that an FSA arrangement will not be permitted to offer both the 2½-month grace period after year-end and the new $500 carry-forward feature.  Consequently, an employer FSA sponsor has to now decide whether to offer (or continue to offer) the grace period, to offer the new $500 carry-forward, or to offer neither.  If neither is offered, the general use-it-or-lose-it rule would continue to apply at year-end with any then-unused amounts being forfeited.
     
    The effective date of this new IRS guidance allowing for up to a $500 FSA carry-forward is immediate, meaning that an employer may adopt it for the current plan year of the cafeteria plan that offers the FSA arrangement, or may instead wait for the start of a future new plan year.  For an FSA arrangement that already offers the grace period feature described in the prior paragraph, a decision to adopt the new $500 carry-forward feature effective immediately would entail a concurrent elimination, mid-plan year, of the grace period, since both features cannot be offered together.  Because employees may have already scheduled medical procedures for soon after year-end in reliance on their ability to use an existing grace period feature, it is probably advisable that FSAs with an existing grace period feature allow it to operate through the grace period immediately following this year-end, and utilize the $500 carry-forward feature, if desired, at the start of a new plan year.
     
    The employer’s Code Section 125 cafeteria plan under which its FSA arrangement operates has to be formally amended if the employer decides to offer this new $500 carry-forward feature.  The general timing rule for adopting such an amendment is that the cafeteria plan has to be amended by the last day of the plan year from which amounts may be carried forward, and the amendment can be made retroactive to the first day of that plan year.  However, for the plan year that begins in 2013, there is a special rule under Notice 2013-71 that allows employers to adopt and implement the new carry-forward feature for the 2013 year, while giving them leeway until the last day of the plan year that begins in 2014 to adopt the required plan amendment.