IRS Allows (Some) Flexibility to FSA “Use It or Lose It” Rule
Joshua L. Cannon
On October 31, 2013, the IRS issued Notice 2013-71, which now allows employees to rollover unused salary deferrals in health flexible spending arrangements (“health FSAs”) offered through Code section 125 cafeteria plans for use in the immediately following year on a limited basis. This is a welcome change to the so-called “use it or lose it” rule applicable to health FSAs.
In general, an employee may make elective salary deferrals of up to $2,500 per year (which is indexed for inflation) into a health FSA offered through a cafeteria plan. Prior to this new guidance, IRS regulations required employees to forfeit any unused salary deferrals in their health FSAs at the end of the plan year. Under an earlier IRS notice, a cafeteria plan is permitted to adopt a “grace period” to provide additional time in which employees could incur reimbursable expenses. This election provided an additional two months and fifteen days after the end of the FSA plan year to incur and be reimbursed for qualified expenses. Assuming a cafeteria plan with a calendar plan year and which provides for such a grace period, an employee could apply unused funds in his or her health FSA from the 2012 plan year towards an expense incurred in January 2013 (and up to February 15, 2013), without reducing the employee’s elective deferrals for the 2013 plan year.
The new Notice now permits an employee to rollover up to $500 of unused health FSA funds for use in the immediately following plan year. Importantly, any rollover does not affect the amount that an employee can elect to defer into a health FSA for such following plan year. Accordingly, an employee who rolls over the maximum $500 can still defer a full $2,500 into his or her health FSA, thus having a total of $3,000 available in his or her health FSA to reimburse qualified expenses for the current plan year.
There are a couple of important caveats to keep in mind regarding this new rollover option. First, in order for employees to utilize this option, the cafeteria plan must be amended to allow for it. Second, the election to permit the rollover of unused funds is made at the expense of the election to provide the grace period; in other words, a cafeteria plan may only allow either unused health FSA funds to be rolled over into the next year, or for unused funds to be used in the 2 month, 15 day grace period, but not both. Third, electing to permit the rollover option does not impact the “run-out” period to submit health FSA claims after the end of the plan year. Finally, employees should be aware that any unused health FSA funds above $500 will continue to be forfeited.
The Notice specifically allows cafeteria plans to be amended to allow for the rollover option for the 2013 plan year. While there are some tradeoffs between the rollover election and the grace period election, employees are likely to be better off in most situations by rolling over unused funds in their health FSAs (up to $500) for use in the next plan year. For plan years ending on December 31, 2013, amendments to allow for rollovers must be adopted no later than the end of the year.
The information contained herein is not intended as and should not be construed as legal advice. Please consult with legal counsel before taking any action based on this information.
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