Drinker Biddle

Publication - 11/21/2013

Use It or Lose It: New IRS Guidance Permits Carryover for Health FSAs

Client Alert
By Heather B. Abrigo and Dawn E. Sellstrom

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:

Issues to Consider

As plan sponsors contemplate this new rule and how it impacts their benefit plans, there are several issues to consider:

What now?

To determine whether to amend health FSAs to allow for the $500 carryover, plan sponsors should consider:

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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