In October, the IRS modified the use-or-lose rule for health FSAs offered under a cafeteria plan.  Prior to this modification, employees who contributed money to these accounts would forfeit any remaining balance at the end of the plan year.  The new modification allows employers the option of including a provision in their cafeteria plan that allows up to $500 of unused health FSA funds to be carried over to the following plan year.  This modification could have significant impact on how much employees plan on contributing to these accounts in the coming year.  

With the adoption of the Patient Protection and Affordable Care Act, a maximum of $2500 was allowed for salary reductions for an FSA.  As a result of this maximum, the IRS reached out to the public and asked what they thought should be done about the use-or-lose rule.  The vast majority favored a modification for the following reasons:

  • The difficulty for employees to predict their future need for health expenses.
  • The desire to minimize incentives for unnecessary spending at the end of the year (or end of the grace period).
  • The possibility that low-income or even moderate-income employees may be reluctant to participate in a health FSA based on the possibility of year-end forfeitures (which could have a more significant impact on these employees).
  • The opportunity to ease and potentially simplify the administration of health FSAs.

The new modification is eligible for employers to include in their 2014 plans, but they would need to re-open enrollment and have this new provision added.  This new modification does not have any effect on the $2500 maximum salary reduction.  Therefore, if an individual were to carry over $500 from the previous year, they may still elect a $2500 salary reduction for the current plan year.

There are concerns that have been expressed in regard to HSA or health savings account plans and an employees’ eligibility for these plans under the new modification.  In previous years, employees were only eligible to participate in an HSA after they had spent all of the money in their health FSA.  Once the money had been used the employee would be eligible to participate.  Under the new modification, without the time limit of the grace period, employees would be ineligible for an HSA unless it had been determined that they had a $0 balance at the end of the plan year.  Unless the IRS uses a similar approach to carry over amounts that it uses for grace periods, or provides other relief, an individual enrolled in a non-HSA compatible health FSA with a carryover provision may be unable to establish or contribute to an HSA for as long as two years.

Other concerns have been raised in regards to how this new modification will affect 2013 FSA plans and whether or not employers wish to offer the carryover option on their 2014 plans.  The IRS has included examples of how the new modification can be utilized in their Guidance report which employers can review and decide if providing this option will be an advantage for their company.

To read the entire article, please visit IRS.gov.