Posting by Billy Thomas

The IRS has released a change to flexible spending accounts (FSAs) under cafeteria plans which addresses the “Use-or-Lose” provision. Essentially, an employer can amend their cafeteria plan to allow participants/employees to rollover up to $500 of unused funds to the following year to reimburse out-of-pocket qualified medical expenses. Treasury estimates that nearly 14 million families participate in these plans, which means that a large base of taxpayers is impacted by the change.

Flexible Spending Accounts and Use-It-Or-Lose-It
Flexible spending accounts, often referred to as FSAs, are employer-sponsored benefit plans allowing participants/employees the opportunity to withhold money from their pay before taxes (up to $2,500) in order to pay out-of-pocket medical expenses incurred during the year. These expenses include co-pays, deductibles, prescriptions, etc.

FSAs have historically created two problems for employees. In order to participate, employees were forced to predict their out-of-pocket medical expenses nearly a year in advance and regulations required the employees to “use” the money or “lose” it if there were amounts remaining unused at year-end.

Updates to Use-It-or-Lose-It Rule
One of the goals of this update to the “Use-or-Lose” rules is to reduce “wasteful year-end FSA healthcare spending by limiting the risk of forfeiture.” The new regulations allow participants to rollover up to $500, but do not require employers to amend plan documents to adopt this change. According to the Treasury (PDF), most forfeited amounts are less than $500.

In 2005 the IRS granted a grace period for employees of up to 2.5 months following the end of the year, permitting additional time to pay for qualified medical expenses with unused funds from the prior year FSA amounts withheld. As with the most recent change, plan sponsors/employers were not required to adopt the grace period provision.

The catch is that an employer can only implement one option or the other, not both. So while there are now two options to manage excess FSA account funds, participants will only have access to the option their plan implements. The Treasury Department states that changes to plan documents can be implemented as early as the 2013 plan year.

In summary:

1. Employers must adopt or amend their current plans to put these new provisions into effect;
2. The total amount eligible to be contributed to a qualified FSA for 2013 and 2014 has remained the same. It is $2,500 regardless of whether the plan adopts the new carryover amounts;
3. FSA plans are not to be confused with Health Savings Accounts (HSAs), which are tied to highly-deductible health plans and are not considered under the cafeteria plan rules mentioned here.

For Additional Details
The IRS notice delves into more detail for employers regarding the amendments to qualified plans including specific rules related the ordering of payments following the year unused amounts have been carried over. For additional details, click here (PDF) to view the notice at the IRS website.