The Internal Revenue Service (IRS) has recently issued guidance providing a modicum of relief to the forfeiture requirements for flexible spending accounts (FSA) under a Section 125 (or “Cafeteria”) Plan. FSA’s are utilized to reimburse employees for allowable medical expenses incurred during a plan year. IRS regulations require that amounts credited to an employee’s FSA that are unused at the end of the plan year must be forfeited. However, a small grace period exists allowing employees to spend unused amounts from the previous year on expenses those employees incur after the end of the plan year but during the first two months and 15 days of the following year.
Under the new guidance, employers may amend their Cafeteria Plans to allow an employee to carry over up to $500 of unused FSA contributions to the next plan year. This carryover will not count towards the employee’s maximum contribution limit of $2,500 per plan year. The carryover amount may also be used to reimburse employees for medical expenses incurred during the entire plan year for which the amounts are carried over (as opposed to the 2 and ½ month limitation under the grace period).
One caveat for employers interested in amending their plans to provide for this carryover is that the employer may not also provide the aforementioned grace period. Thus, employers can choose to have one of the following: a full forfeiture at the end of a plan year, a 2 and ½ month grace period for claims incurred during that period, or a $500 carryover for claims incurred in the next plan year. However, the new guidance does not affect the use of a “run-out” period which immediately follows the end of a plan year during which employees can submit claims to reimburse expenses incurred during that plan year.
All other FSA provisions remain the same (such as the fact that such amounts cannot be cashed out or applied to other taxable or nontaxable benefits offered). The carryover is limited to $500 each year and amounts carried over that are used to pay current plan year expenses must be counted against the carryover amount only after new, current year, salary reductions have been exhausted.
An employer who wishes to amend their document to provide this provision must adopt an amendment before the end of the plan year and such amendments may be effective retroactively to the beginning of the plan year. Amendments for the current 2013 plan year must be adopted before the end of the plan year ending in 2014. (Caution should also be noted for plans that are not pre-empted by ERISA—church and governmental plans—as the ability to remove a grace period for the current plan year may be subject to non-Code legal constraints).