In Notice 2013-71 (Notice), the Internal Revenue Service (IRS) relaxed its longstanding “use-it-or-lose-it” rule for health flexible spending accounts (Health FSAs). Employees may now be permitted to carry over up to $500 of their unused Health FSA balances to the following plan year to reimburse expenses incurred in that following year.
Health FSAs under a cafeteria plan allow employees to be reimbursed for certain medical expenses that are not covered by their major medical plans. Contributions to a Health FSA are made on a pre-tax basis in accordance with section 125 of the Internal Revenue Code (Code), and reimbursements used to pay qualified medical expenses are not taxed. Historically, employees eligible for Health FSAs have been subject to the “use-it-or-lose-it” rule, meaning that contributions for any plan year may be used solely to reimburse expenses incurred during that year, and any unused account balances at year-end are forfeited. In 2005, the IRS modified these rules to provide that plans could offer a grace period, allowing employees to use their account balances remaining at year-end to reimburse expenses they incur during a period of up to 2½ months following the end of the plan year.
Many have pushed for additional changes to the “use-it-or-lose-it” rule, citing the difficulty of predicting future medical expenses and the reluctance of lower paid employees to participate in Health FSAs due to the potential forfeitures. The IRS indicated a possible willingness to provide more flexibility in Notice 2012-40, which provided guidance on applying the $2,500 annual limit on contributions to a Health FSA under Code section 125(i).
In an effort to make Health FSAs more employee-friendly and ease administrative burdens, Notice 2013-71 provides the following:
An employee may now carry over up to $500 in unused contributions for one plan year to reimburse expenses incurred during the following plan year, to the extent permitted by the plan;
Plans may provide for a carryover limit that is less than $500;
Unused amounts in excess of $500 (or a lower amount specified in the plan) will still be forfeited at year-end;
Any amount carried over will not count against the employee’s contribution limit for the following plan year;
A plan may treat expenses incurred in the current plan year as reimbursed first from amounts credited for the current plan year, and then as reimbursed from unused amounts carried over from the prior plan year;
Use of the carryover option does not impact the plan’s ability to offer a claims run-out period after the end of a plan year for an employee to submit claims incurred during the year; and
A plan may offer either the carryover option or a grace period, but not both.
Examples make clear that contributions can be carried over from year to year. One example describes a situation in which an amount is carried over from 2014 to 2015 and then again to 2016.
Plans may begin offering the carryover option as early as the 2013 plan year. To implement the carryover option, employers must take the following actions:
Amend plan documents to allow for the carryover option; and
Amend plan documents to remove any grace period.
Amendments generally must be adopted on or before the last day of the plan year from which amounts may be carried over, and may be effective retroactive to the first day of that plan year, provided the plan is operated in accordance with Notice 2013-71 and employees are notified of the carryover option. Under a special rule, amendments for the 2013 plan year need not be adopted until the end of the 2014 plan year. The Notice also provides special rules for amending a plan that has offered the grace period to instead provide for the carryover and notes that there may be legal constraints that preclude an employer from retroactively amending a plan to eliminate the grace period for the current plan year.
In addition, the Notice clarifies the scope of certain transitional relief that applies to non-calendar year cafeteria plans.
Effective January 1, 2014, health care coverage will be available through the government-run health insurance exchanges. This date falls in the middle of the 2013 plan year for non-calendar year cafeteria plans, and the availability of coverage through the exchanges is not considered an event that would allow employees to revoke or change their cafeteria plan elections mid-year. To accommodate employees who may wish to purchase coverage through an exchange, the preamble to proposed regulations under Code section 4980H provides that non-calendar year cafeteria plans may be amended to allow employees to make a prospective change to their elections during the 2013 plan year.
The Notice clarifies that this transition relief applies to all employers with a non-calendar plan year, regardless of their size, and provides that employers may adopt more restrictive cafeteria plan amendments than those described above. For example, rather than allowing employees to change or revoke their cafeteria plan elections at any time during the 2013 plan year, an employer could amend its plan to provide that employees may only change or revoke their elections during January 2014.