IRS Chips Away at the FSA "Use-or-Lose" Rule

by Epstein Becker & Green

Health care flexible spending accounts ("FSAs") established pursuant to a cafeteria plan under Section 125 of the Internal Revenue Code of 1986, as amended, have long permitted employees to make pre-tax salary contributions to an account in order to receive reimbursements to pay for certain qualifying medical benefits that are not reimbursed through insurance or another arrangement. In order to participate in an FSA, an employee must elect in advance of the plan year the amount of pre-tax pay that he or she wants to use for that year, and amounts that remain unused at the end of a plan year must be forfeited. This so-called "use-or-lose" rule, although based on other related tax law principles, has been criticized by many as forcing employees to make guesses about their future level of use of their FSAs, and the rules arguably push participants into incurring expenses at year end simply to avoid forfeiting funds. The impact of the "use-or-lose" rule was somewhat lessened in 2005 by Internal Revenue Service ("IRS") Notice 2005-42, which allows a plan to include provisions that provide for reimbursement of certain qualifying medical expenses incurred during a 2½-month grace period following the end of the plan year. Any amount not used by the end of the grace period would still be subject to forfeiture.

Then, in connection with the Patient Protection and Affordable Care Act's imposition of a $2,500 (indexed for cost-of-living adjustments) limit on employee salary reduction contributions to health FSAs (effective for plan years beginning in 2013), in Notice 2012-40, the Treasury Department and IRS sought comments as to whether the "use-or-lose" rule should be modified. On October 31, 2013, the Treasury Department and the IRS issued Notice 2013-71, which provides plan sponsors with flexibility in plan design with regard to the "use-or-lose" rule as well as additional clarifications regarding salary reduction elections for non-calendar year cafeteria plans.

Under the new guidance, Section 125 cafeteria plans can be, but are not required to be, amended to allow up to a maximum of $500 of unused amounts remaining at the end of a plan year in a participant's FSA to be carried over to the next plan year and used to reimburse the plan participant for qualified medical expenses incurred during the immediately following plan year so long as the plan does not also use the grace period rule. An employer will have to choose which of the two rules, grace period or carry-over, it wishes to include in its cafeteria plan, although neither rule is required.

This carryover can apply to the entire plan year to which it is carried and will not affect the $2,500 cap on salary reduction contributions that the participant is otherwise eligible to elect for the new plan year. For administrative ease, Notice 2013-71 provides that the cafeteria plan can use a "first in, first out" approach and treat reimbursements of all claims for expenses that are incurred in the current plan year as reimbursed first from unused amounts credited for the current plan year and, then, after using such amounts, as reimbursed from unused amounts carried over from the preceding plan year.

Plans that wish to use the carryover approach under Notice 2013-71 must be amended to provide for the carryover provisions and, if applicable, eliminate the grace period rule provisions. The amendments must be adopted on or before the last day of the plan year from which amounts may be carried over and can be effective retroactively to the first day of that year, provided that the plan is operated in accordance with the guidance in Notice 2013-71 and participants are informed of the new provisions. Notice 2013-71 further provides that a plan may be amended to adopt the carryover provision for a plan year that begins in 2013 at any time on or before the last day of the plan year that begins in 2014. Coordination of these requirements may make it difficult to take advantage of these design options until proper planning can be undertaken and communicated to participants. The Treasury Department and IRS also intend to amend the proposed cafeteria plan regulations under Prop. Treas. Reg. Sections 1.125-1(o) and 1.125-5(c) to reflect the guidance in Notice 2013-71, and taxpayers may rely on the guidance in Notice 2013-71 until such amended regulations are effective.

It is worth noting that Notice 2013-71 also clarifies the scope of the transition relief that was set forth in the preamble to the proposed regulations on the employer shared responsibility provisions under the Patient Protection and Affordable Care Act with regard to changes in elections for non-calendar year plans. Under the clarification, non-calendar year cafeteria plans can be amended to allow employees to make a mid-year change to their elections so that they may, for example, cease coverage under the employer plan and purchase coverage in the Health Insurance Marketplace, regardless of whether the employer is a small or large employer.

Many participants and employers have, for a long time, criticized the "use-or-lose" requirement as being far too rigid. For many employees, even relatively small forfeitures posed a hardship. Although some would certainly have preferred to see the "use-or-lose" rule completely repealed, Notice 2013-71 should nonetheless provide a bit of welcome relief to critics of the rule and provide employers with planning opportunities for their cafeteria plan designs.

* * *

IRS Circular 230 Disclosure

To ensure compliance with certain IRS requirements, we inform you that any tax advice contained in this publication is not intended or written to be used, and cannot be used, for the purpose of avoiding penalties under the Internal Revenue Code.


DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Epstein Becker & Green | Attorney Advertising

Written by:

Epstein Becker & Green

Epstein Becker & Green on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Custom Email Digest
Privacy Policy (Updated: October 8, 2015):

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.


JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at:

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.