- Health and Welfare: Modification of "Use-or-Lose" Rule for Health FSAs
- November 8, 2013 | Author: C. Frederick Oliphant
- Law Firm: Miller & Chevalier Chartered - Washington Office
On October 31, 2013, Treasury published Notice 2013-71 ("Notice") which liberalizes the FSA "Use-or-Lose" rule ("Use-or-Lose" or the "Rule"). Use-or-Lose requires that unused amounts remaining at the end of a plan year in a health FSA be forfeited to the employer. The Rule derives from the Internal Revenue Code ("Code") Section 125's prohibition on arrangements that have the effect of deferring compensation under a cafeteria plan. In 2005, Treasury and the IRS acted to mitigate the effect of Use-or-Lose by permitting unused amounts to be used to cover expenses incurred for certain qualified benefits arising in the 2-1/2 month period following the end of the plan year ("Grace Period Rule").
The new Notice will now permit employers to amend their cafeteria plan documents to provide for the carryover of up to $500 of remaining amounts in a health FSA to the immediately following plan year to pay for or reimburse plan participants for qualified medical expenses during the entire plan year to which it is carried over. The carryover amount does not count against or otherwise affect the indexed $2,500 salary reduction limit for each plan year and it still must be used only to pay for or reimburse qualified medical expenses (i.e., no cash-out or conversion to other benefits is permitted). Under the Notice, an employer may choose to adopt the new carryover rule or the old Grace Period Rule, but not both.
To take advantage of the new carryover provision, the Notice specifies that the employer must amend its cafeteria plan document on or before the last day of the plan year from which amounts may be carried over and that such amendment may be effective retroactively to the first day of the plan year, provided the cafeteria plan operates in conformity with the Notice and notifies participants of the carryover provision. Special transition relief is afforded with respect to this amendment requirement -- an employer may adopt the amendment giving effect to the carryover provision for a plan year that began in 2013 as late as the end of the plan year that begins in 2014. Note that if the cafeteria plan currently provides for the Grace Period Rule, and the employer wishes to adopt the new carryover provision, the Grace Period Rule must be removed by no later than the end of the plan year from which the amounts may be carried, and there does not appear to be any transition relief granted with respect to this requirement, so that for cafeteria plans with a plan year beginning in 2013, it appears that the Grace Period Rule must be eliminated by the end of that plan year if the employer wishes to adopt the new carryover provision. The Notice further cautions that the employer's ability to eliminate the Grace Period Rule for a plan year after the plan year has already started may be subject to other (i.e., non-tax) legal constraints.
The Notice also clarifies certain prior cafeteria plan transition relief for mid-year elections issued in connection with the proposed regulations under Code Section 4980H. This relief permits employers that offer non-calendar year cafeteria plans that begin in 2013 to amend their plan documents for the plan year beginning in 2013 to allow one or both of the following election changes: (1) Permit their employees who have elected a salary reduction to prospectively revoke or change their election with respect to the accident and health plan once during that plan year; or (2) Permit their employees who have failed to make a salary reduction election prior to the amendment, to make a prospective salary reduction election on or after the first day of the 2013 plan year of the cafeteria plan. The Notice clarifies that this relief is available whether or not the employer is an applicable large employer subject to the "pay or play" penalties under Code Section 4980H, and that employers may choose to apply this relief in a more restrictive manner.