IRS Guidance Provides An Alternative to the Current “Grace Period Rule”

The Internal Revenue Service recently released Notice 2013-71, which provides an alternative to the Grace Period Rule for health flexible spending arrangements (FSA). Under this alternative, cafeteria plans may now allow employees to carry over up to $500 of unused amounts remaining in a health FSA at the end of the plan year into the immediately following plan year. If implemented by the employer, the carryover method does not affect the $2,500 annual limitation on health FSA contributions.

Many cafeteria plans offering health FSAs presently use the Grace Period Rule. That rule allows any amount left in a health FSA at the end of a plan year to be used for the reimbursement of qualified expenses in the first 2½ months of the immediately following plan year. Any amounts not used during the grace period are then forfeited. The Notice allows employers to eliminate the Grace Period Rule, and instead allow up to $500 to be carried into the next year. The carried over amount is then available for reimbursement of qualified expenses during the entire plan year.

Employers that currently have a grace period will need to determine whether it should be replaced by the carryover method. Employers that wish to implement the carryover method, whether or not they currently use the Grace Period Rule, will need to amend their cafeteria plan. The amendment must be adopted by the last day of the plan year from which amounts may be carried forward, and may take effect retroactively to the beginning of that year if plan participants are informed of, and the plan is operated in accordance with, the carryover method. Further, the Notice provides that the carryover method may be adopted for plan years beginning in 2013 if the amendment is adopted by the last day of the plan year that begins in 2014.