The IRS has relaxed the rule
that any amounts remaining at the end of a plan year in a health flexible
spending account (health FSA) must be forfeited. But whether cafeteria plans
should be amended to include this new provision is a question plan sponsors
should consider carefully.
Under IRS Notice 2013-71
(Notice), issued on October 31, 2013, a cafeteria plan may permit up to $500 in
an employeefs health FSA remaining unused at the end of a plan year to be
carried over and used to reimburse medical expenses incurred in the entire
following year. This is a change to the long-standing guse-or-loseh rule that
restricted employees from carrying over amounts to a subsequent year. The change
comes as a result of comments the IRS received after the release of Notice
2012-40, which provides guidance on the $2,500 maximum limit on the amount of
salary deferrals an employee may contribute to a health FSA. In this Alert, we
provide background on the old rule, explain how it is modified by the Notice and
discuss some of the outstanding issues that plan sponsors will need to address
in deciding whether to implement the new carryover feature.
Adding the carryover feature
will require (1) an amendment to the plan, (2) elimination of the grace period
feature if the cafeteria plan has one, and (3) notice to participants about the
changes as soon as possible if they are being implemented for 2014. In addition,
there are considerations related to COBRA, HIPAA and HSAs that need to be
understood. All of these are covered in more detail below.
Background
A cafeteria plan that includes
a health FSA may allow participants to make pre-tax salary deferral
contributions to the health FSA up to $2,500 (for 2013, and indexed for
inflation for plan years beginning after December 31, 2013; however, the $2,500
limit is unchanged for 2014). To help participants who may have a balance in
their health FSA at the end of a plan year, cafeteria plans may also provide for
a grun-out periodh and/or ggrace period.h To the extent that participants do not
exhaust their health FSA balance at the end of the run-out period and/or grace
period, under the current rules, any amount remaining is forfeited.
A run-out period is a period
after the end of the plan year during which a participant may submit claims for
expenses for eligible medical expenses incurred during that prior plan year. So,
for example, if a participant deferred $2,000 in 2013, incurred $2,000 of
covered medical expenses in 2013, but sought reimbursement for only $1,700 of
those expenses prior to the end of the plan year, he would be able to submit
reimbursement claims for the remaining $300 during the run-out period in 2014.
However, unless the FSA also has a grace period, he could not submit claims for
new expenses incurred in 2014 during the run-out period.
A grace period extends the
period during which a participant may incur eligible expenses for up to 2-1/2
months after the close of a plan year. A run-out period may follow a grace
period, but IRS rules limit a permitted grace period to no longer than 2-1/2
months after the end of a plan year.
It is important to note that
the cafeteria plan document must provide for the run-out and/or grace
periods.
The new $500 carryover
rule
The Notice permits plan
sponsors to implement a carryover feature under which up to $500 in a health FSA
that remains at the end of the plan year will be carried over into the following
year. However, in order to implement the new carryover rule, plan sponsors
should be aware of the following:
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Purpose. The carryover amount may
be used to pay or reimburse medical expenses incurred during the entire plan
year to which it is carried over (e.g., the participant may use the
$500 carryover from 2013 for eligible expenses incurred at any time in
2014).
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Salary Deferral Limit. The $500
carryover does not count toward the $2,500 annual limit on salary deferrals. A
participant may carryover $500 from his or her unused health FSA balance from
2013 into 2014, and may also elect to contribute the full $2,500 limit for
2014.
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No Grace Period Permitted. A
cafeteria plan may not have a grace period in the year into which an
amount is carried over under the $500 carryover feature, but may have a grace
period for the prior year. For example, a plan may provide for a carryover of
$500 from the 2013 plan year to the 2014 plan year. It is acceptable if the
FSA had a grace period at the beginning of 2013 (for amounts not used under
the 2012 FSA), but it must eliminate the grace period in 2014 (related to 2013
account balances). A health FSA may continue to feature a run-out period, even
if a carryover feature is added.
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Amendments. Plan sponsors must
amend their cafeteria plans by the last day of the plan year from which the
carryover is permitted, and the amendment should be retroactive to the first
day of that plan year. There is an exception for the 2013 plan year. Plan
sponsors that want to amend their health FSA for the plan year beginning in
2013 to allow for the carryover into 2014 must amend their plans no later than
the last day of the plan year that begins in 2014 (or December 31, 2014 in the
case of a calendar year plan). For non-calendar year plans, the deadline to
adopt the amendment to add a carryover feature may go well beyond 2014. For
example, if a cafeteria plan has a plan year ending June 30, the plan year
that begins in 2013 begins on July 1, 2013 and ends June 30, 2014. That health
FSA must be amended by June 30, 2015 to allow for the carryover (the last day
of the plan year that begins in 2014).
Special timing rules apply if
a health FSA must also eliminate a grace period. To the extent that a plan
sponsor wants to add a carryover feature in a health FSA that already has a
grace period in place, the plan must also be amended to eliminate the grace
period for that year. An amendment to eliminate a grace period must be adopted
by no later than the end of the plan year from which amounts may be carried
over. Thus, to implement a carryover feature for 2013 accounts, a health FSA
with a calendar year plan year would have to be amended by the end of 2013
(i.e., the plan year from which amounts may be carried over) to eliminate the
upcoming grace period.
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Notice Required. If plan sponsors
want to adopt the carryover feature, they will have to notify participants
about the new feature. It may be necessary to provide the notice to
participants in advance of the deadline to adopt a plan amendment. For
example, if plan sponsors want to amend their plans in 2013, they have until
the end of 2014 to adopt the amendment (for calendar year-end plans, and as
long as a grace period is not also being eliminated). However, participants
should be notified as soon as possible about the carryover feature since it
will impact their 2013 balances, and the amount available for reimbursements
in 2014.
Employers that adopt the carryover for 2013 balances, and
currently have a grace period in place, will want to communicate the change
clearly and expeditiously. This is because participants may be planning on
using more than $500 of their 2013 health FSA balance for expenses they are
planning to incur during the 2014 grace period, which will have to be
eliminated.
Issues to Consider
As plan sponsors contemplate
this new rule and how it impacts their benefit plans, there are several issues
to consider:
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Impact on HSA participation. Employees that
are covered by ggeneral purposeh health FSAs, which generally permit the
reimbursement of any eligible medical expense, are not eligible to make
contributions to an HSA because the FSA coverage is considered disqualifying,
non-high deductible health plan (HDHP) coverage. The Notice does not address
how the $500 carryover impacts an employee who elects to be covered under a
HDHP for the plan year into which an amount is carried over, and thus also
wants to make contributions to an HSA for that year. Based on the available
guidance concerning HSAs and health FSA grace periods, such a carryover may
cause the employee to be ineligible for an HSA.
Although the IRS has
not yet addressed these issues related to the new carryover feature, available
guidance related to grace periods and their impact on HSAs may provide plan
sponsors with some potential solutions. For example, plan sponsors may want to
consider adding an opt-out provision related to the carryover for such
employees wanting to make contributions to an HSA. Alternatively, plan
sponsors may want to consider converting the carryover amount to a limited
purpose HSA-compatible FSA that may include: (i) a limited-purpose health FSA
(i.e., a health FSA that reimburses only dental, vision, and/or preventive
care expenses); (ii) a post-deductible health FSA (i.e., a health FSA that
reimburses medical expenses only if incurred after the Code ˜223(c)(2)(A)(i)
minimum annual deductible has been satisfied); or (iii) a combination
limited-purpose and post-deductible health FSA. Again, these options have not
yet been addressed by the IRS specifically related to the carryover feature so
we strongly urge plan sponsors to consult with their benefits counsel before
proceeding.
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Impact on COBRA obligations. Another issue
is how the new carryover rule affects COBRA. Generally, health FSAs are
considered group health plans and are subject to COBRA obligations. Any unused
amounts remaining in an employeefs health FSA as of termination of employment
and eligibility under the health FSA may be forfeited, unless the employee
elects COBRA coverage, subject to certain exceptions. One such exception
limits COBRA coverage available under a FSA that is an gexcepted benefith
(i.e., the health FSA limits the maximum amount that may be reimbursed and
other major medical coverage is available -- see our further discussion
below). COBRA is required only if the participant has an underspent health
FSA. In that situation, he or she must be offered COBRA through the end of the
plan year of the qualifying event.
The Notice provides only that any
unused amounts remaining in an employeefs health FSA at termination of
employment is forfeited unless that employee elects to continue participation
in the health FSA by electing COBRA. The Notice does not address how to handle
an employeefs (or other qualified beneficiaryfs) COBRA election under a health
FSA that includes a carryover provision. While it appears, based on the IRSf
statement in the Notice, that qualified beneficiaries under COBRA may benefit
from the carryover, at least to some extent, it is not clear how qualified
beneficiaries should benefit under COBRA from a carryover, or for how long.
IRS guidance on this issue is needed.
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Excepted Benefits Under HIPAA. A health FSA
will qualify as an gexcepted benefith under HIPAA and the Patient Protection
and Affordable Care Act of 2010 (PPACA) if the maximum amount that may be
reimbursed under the health FSA is limited to the greater of (i) two times the
participantfs salary reduction, or (ii) the participantfs salary reduction
plus $500. The employer must also make other major medical coverage available
to participants. For example, a health FSA is an excepted benefit if the plan
sponsor does not make any contribution to the health FSA or does not
contribute more than $500 to the health FSA and other major medical coverage
is available. However, it is not clear how adding a carryover feature will
impact certain FSAs (e.g., one with employer contributions), and if it could
cause the health FSA to fail to meet the exception.
Many typical
health FSAs accept only employee salary deferral contributions and will be
excepted benefits, even if the carryover feature is implemented. If a health
FSA does not qualify as an excepted benefit, however, the health FSA is
subject to HIPAAfs special enrollment and other portability rules. A health
FSA that does not qualify as an excepted benefit is also subject to many of
PPACAfs mandates.
What now?
To determine whether to amend
health FSAs to allow for the $500 carryover, plan sponsors should consider:
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Whether the plan should be amended for 2013 or for 2014 to provide for
the carryover. If a plan sponsor decides to implement the carryover for 2013,
it should immediately determine how to communicate the change to employees,
and make sure that the plan is amended to eliminate the grace period for 2014,
if any. Plan sponsors need to be cognizant of how such a change will affect
their employees that will have more than $500 in their health FSA and expect
to utilize that balance in the grace period;
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The impact this might have on individuals who are currently
contributing to a health FSA but may elect coverage under a HDHP and wish to
start participating in a HSA; and
-
How this rule impacts terminated employees and the planfs COBRA
obligations.
If you would like to discuss the impact of these new rules on your health
FSA, please contact your Drinker Biddle benefits
lawyer.
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