IRS Modifies "Use-or-Lose" Rule For Health Flexible Spending Arrangements

In the recently released Notice 2013-71, the Internal Revenue Service (IRS) modified the rules for flexible spending accounts (FSAs).  As previously applied, the rules did not allow for carryover of employee salary reduction contributions, otherwise known as the “use-or-lose” rule.  The Notice permits cafeteria plans to be amended to allow for a carryover of up to $500 remaining at plan year end into the next plan year to pay or reimburse plan participants for qualified medical expenses, provided that certain requirements are met.  The Notice also clarifies the scope of transition relief that allows for greater flexibility for individuals who desire changes in salary reduction elections for accident and health plans for non-cafeteria plan years beginning in 2013.  These changes and clarifications were prompted by questions that arose under the Affordable Care Act (ACA).

This new IRS Notice modifies the use-or-lose rule to permit up to $500 of unused employee contributions to be carried over into the health FSA in the immediately following plan year.  The carryover can be used to pay or reimburse medical expenses incurred at any point during the plan year into which it was carried over.  Also, the carryover does not count against the ability of the employee to make a salary reduction of up to $2,500.  In practice, this means that employees could have up to $3,000 per plan year for reimbursement purposes. 

The modification to the use-or-lose rule is an option for employers; in other words, employers are not required to implement it.  If an employer does decide to implement the carryover, it must apply this option  equally to all plan participants.  If an employee’s health spending account has in excess of $500 at the end of the plan year, the excess will still be forfeited.  While a grace period for incurring expenses will not be allowed, use of the carryover option will not prevent the health FSA from allowing for the payment of expenses incurred in one plan year during a permitted run-out period at the beginning of the following plan year. 

To implement the carryover option, a Section 125 cafeteria plan must be amended on or before the last day of the plan year from which amounts will be carried over. However, any elimination of a grace period would need to be adopted prior to December 31, 2013.  Plan participants must be informed of the new carryover provision.  Employers can adopt the carryover provision for a plan year that begins in 2013 at any time on or before the last day of the plan year that begins in 2014. 

The Notice also clarifies the scope of the transition rule regarding salary reduction elections for non-calendar plan years beginning in 2013.  In general, Section 125 cafeteria plan elections must be made before the start of the plan year and are irrevocable during the plan year (except in limited circumstances).  However, since the existence of health insurance through an ACA Insurance Exchange does not constitute a change in status, employees cannot change their salary reduction elections for health coverage during a plan year in order to cease their salary reductions and purchase coverage through an Exchange.  Thus, the Treasury Department implemented transition relief with respect to salary reductions under a Section 125 cafeteria plan for an employer-provided accident and health plan with a non-calendar year plan year beginning in 2013.  The Notice clarifies that transition relief is available whether or not the employer is an applicable large employer member under Section 4980H (i.e., an employer who has 50 or more full-time or full-time equivalent employees and is subject to the employer responsibility requirements under the ACA).  The Notice further clarifies that an amendment to a Section 125 cafeteria plan adopted pursuant to the transition relief may be more restrictive than described in the relief, but cannot be less restrictive. 

Employers should review their cafeteria plan documents, as well as participant communications.  In addition, if the employer sponsors a health savings account (HSA), care must be taken to coordinate plan provisions.

Information contained in this publication is intended for informational purposes only and does not constitute legal advice or opinion, nor is it a substitute for the professional judgment of an attorney.