Recently the Internal Revenue Service published guidance that permits an employer to amend its health care flexible spending account program (HFSA) to allow a limited carryover of funds. In IRS Notice 2013-71, the IRS provides for a new exception to the “use it or lose it” requirements by allowing an employer to permit up to $500 in unused HFSA amounts from one year to be used for claims incurred in the next year. However, as with many tax-favored benefits, employers should carefully consider the requirements and potential consequences before implementing the change in their HFSA.
HFSAs generally permit employees to elect to reduce their pay before tax and have the money available during the plan year to pay for qualifying medical expenses. In the past, the IRS has been concerned about these elections being used to defer income from one year to the next. As such, the HFSA rules initially provided that amounts set aside and not used during the year by the participant would be lost, a rule commonly referred to as “use it or lose it.” This rule appeared to have a chilling effect on many workers who were concerned about the possible loss of money, and therefore did not participate in the HFSA. Even among those who chose to participate in the HFSA, there was often a year-end run for possibly unnecessary medical items to avoid loss of funds. We have even heard stories about eyeglasses being bought at the end of December and returned for cash in January.
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