United States: IRS Notice Adds Choices to Cafeteria Plans

On October 31, the Internal Revenue Service (IRS) issued Notice 2013-71, which modifies the "use it or lose it" rule for health flexible spending account plans (Health FSAs) by providing a carryover option for unused amounts remaining at the end of a plan year. Under this carryover option, cafeteria plans that provide a Health FSA may be amended to allow up to $500 of unused amounts remaining at the end of a plan year to be paid from the Health FSA for qualified medical expenses incurred in the following plan year. In addition, Notice 2013-71 expands the transition relief for non-calendar cafeteria plan years by permitting midyear changes in salary reduction elections attributable to a participant's purchase of health coverage through an Affordable Insurance Exchange established under the Patient Protection and Affordable Care Act (the Affordable Care Act).

The Use-It-or-Lose-It Rule


Under the current cafeteria plan rules, participants are generally prohibited from using contributions made in one plan year to purchase a benefit that will be provided in a subsequent plan year. Accordingly, amounts credited to a Health FSA that remain unused at the end of a plan year are generally forfeited. This is commonly referred to as the "use it or lose it" rule. The IRS previously modified this rule by providing a grace period, which allows a plan to permit participants to use amounts remaining from the previous year to pay for qualified medical expenses incurred within the first 2 ½ months of the following plan year (i.e., by March 15 for calendar year plans). The Affordable Care Act limited the amount that participants could contribute to their Health FSAs to $2,500 per taxable year (as indexed for cost-of-living adjustments). In light of this annual limit imposed by the Affordable Care Act, the Department of the Treasury and the IRS issued Notice 2012-40, in which they solicited public comments addressing whether the use-it-or-lose-it rule should be modified to provide a different form of administrative relief (e.g., instead of, or in addition to, the 2 ½-month grace period). Notice 2013-71 was issued in response to these public comments.

Modification of Use-It-or-Lose-It Rule

Effective immediately, employers may amend their cafeteria plan to provide for a carryover of up to $500 to the immediately following plan year of any amounts remaining in a Health FSA. The $500 carryover can be used to pay or reimburse medical expenses under the Health FSA incurred during the entire subsequent plan year (i.e., it extends beyond the current 2 ½-month grace period). Some of the highlights of the carryover option are as follows:

  • Employers adopting the carryover cannot also offer the
    2 ½-month grace period for Health FSAs. Thus, the employer must choose between the forms of relief.
  • The carryover does not count against or otherwise affect the Health FSA contribution limit for a plan year. This means that in addition to the carryover, employees can still defer the maximum allowable salary reduction to their Health FSA (i.e., $2,500 for 2014).
  • Employers may specify a lower amount or choose not to permit a carryover. However, if an employer adopts a carryover, the same carryover limit must apply to all plan participants. Effectively, this means participants may carry over the lesser of (i) any unused amounts in their Health FSA from the immediately preceding plan year, or (ii) the amount specified in the plan (which cannot exceed $500). Note, the carryover is not available for terminated participants.
  • Any unused amount in excess of the carryover amount will be forfeited.
  • Cafeteria plans are permitted to treat reimbursements of all claims and expenses that are incurred in the current plan year as reimbursed first from current plan year contributions, and only after exhausting those current plan year amounts will claims and expenses be reimbursed from any carryover amounts.

An employer must amend its cafeteria plan to take advantage of the carryover option. Generally, any amendments must be made no later than the last day of a plan year in which the carryover will apply. However, Notice 2013-71 provides an extended amendment period to the end of the 2014 plan year for a carryover amendment being adopted for the 2013 plan year. Employees must be provided with notice of the employer's adoption of the carryover amendment.

One question that Notice 2013-71 does not address is how the carryover would impact the ability of participants to contribute to their health savings accounts (HSAs) in years in which the carryover is available. In general, participants who are covered by a general-purpose Health FSA are prohibited from contributing to an HSA. We are hopeful the IRS will quickly issue additional guidance addressing this question.

Action Steps for Employers

Because this guidance offers employers a choice, employers should do the following:

  • Consider whether the carryover option is right for their cafeteria plan design, e.g., would the grace period rule or the carryover option be more beneficial? Does the potential impact on HSA eligibility make it undesirable?
  • Review their cafeteria plan documents to determine what amendments, if any, will be required. Note, if a cafeteria plan provides for a grace period and is being amended to adopt the new carryover option, the amendment must eliminate the grace period provision by no later than the end of the plan year from which amounts may be carried over.
  • Prepare employee communications describing the changes to the Health FSA.

Clarification of Cafeteria Elections and Affordable Insurance Exchanges


Generally, salary reduction elections under a cafeteria plan must be made before the beginning of the plan year and are irrevocable during the plan year, with limited exceptions (such as change in status events). Under existing cafeteria plan rules, obtaining health plan coverage through an Affordable Insurance Exchange would not constitute a change in status, and therefore employees would not be able to cease their cafeteria plan coverage. The Department of the Treasury and the IRS previously addressed this issue in the preamble to proposed regulations setting forth the employer shared responsibility rules, commonly referred to as the employer mandate provisions or pay or play rules. These rules apply to "applicable large employers" (i.e., generally employers that employ an average of at least 50 full-time employees). Specifically, the preamble permits an employer to amend its non-calendar year cafeteria plan for 2013 to allow employees to make either or both of the following changes to their salary reduction elections:

  1. An employee may prospectively revoke or change his or her election with respect to the accident and health plan once during that plan year.
  2. An employee who failed to make a salary reduction election under a cafeteria plan for accident and health coverage is allowed to make a prospective salary reduction election for accident and health coverage on or after the first day of the plan year.


In Notice 2013-71, the IRS clarified that the transition relief described above is available to all employers with a non-calendar year cafeteria plan, not just those that are considered to be "applicable large employers." Additionally, Notice 2013-71 clarifies that employers may impose more restrictive rules than what the notice allows, including permitting employees to prospectively revoke their salary reduction elections only during a limited number of months in a plan year. Employers wishing to provide this transition relief must adopt plan amendments by December 31, 2014.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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