United States: Use It Or Lose It: New IRS Guidance Permits Carryover For Health FSAs

Last Updated: November 26 2013
Article by Heather Abrigo and Dawn Sellstrom

The IRS has relaxed the rule that any amounts remaining at the end of a plan year in a health flexible spending account (health FSA) must be forfeited. But whether cafeteria plans should be amended to include this new provision is a question plan sponsors should consider carefully.

Under IRS Notice 2013-71 (Notice), issued on October 31, 2013, a cafeteria plan may permit up to $500 in an employee's health FSA remaining unused at the end of a plan year to be carried over and used to reimburse medical expenses incurred in the entire following year. This is a change to the long-standing "use-or-lose" rule that restricted employees from carrying over amounts to a subsequent year. The change comes as a result of comments the IRS received after the release of Notice 2012-40, which provides guidance on the $2,500 maximum limit on the amount of salary deferrals an employee may contribute to a health FSA. In this Alert, we provide background on the old rule, explain how it is modified by the Notice and discuss some of the outstanding issues that plan sponsors will need to address in deciding whether to implement the new carryover feature.

Adding the carryover feature will require (1) an amendment to the plan, (2) elimination of the grace period feature if the cafeteria plan has one, and (3) notice to participants about the changes as soon as possible if they are being implemented for 2014. In addition, there are considerations related to COBRA, HIPAA and HSAs that need to be understood. All of these are covered in more detail below.

Background

A cafeteria plan that includes a health FSA may allow participants to make pre-tax salary deferral contributions to the health FSA up to $2,500 (for 2013, and indexed for inflation for plan years beginning after December 31, 2013; however, the $2,500 limit is unchanged for 2014). To help participants who may have a balance in their health FSA at the end of a plan year, cafeteria plans may also provide for a "run-out period" and/or "grace period." To the extent that participants do not exhaust their health FSA balance at the end of the run-out period and/or grace period, under the current rules, any amount remaining is forfeited.

A run-out period is a period after the end of the plan year during which a participant may submit claims for expenses for eligible medical expenses incurred during that prior plan year. So, for example, if a participant deferred $2,000 in 2013, incurred $2,000 of covered medical expenses in 2013, but sought reimbursement for only $1,700 of those expenses prior to the end of the plan year, he would be able to submit reimbursement claims for the remaining $300 during the run-out period in 2014. However, unless the FSA also has a grace period, he could not submit claims for new expenses incurred in 2014 during the run-out period.

A grace period extends the period during which a participant may incur eligible expenses for up to 2-1/2 months after the close of a plan year. A run-out period may follow a grace period, but IRS rules limit a permitted grace period to no longer than 2-1/2 months after the end of a plan year.

It is important to note that the cafeteria plan document must provide for the run-out and/or grace periods.

The new $500 carryover rule

The Notice permits plan sponsors to implement a carryover feature under which up to $500 in a health FSA that remains at the end of the plan year will be carried over into the following year. However, in order to implement the new carryover rule, plan sponsors should be aware of the following:

  • Purpose.The carryover amount may be used to pay or reimburse medical expenses incurred during the entire plan year to which it is carried over (e.g., the participant may use the $500 carryover from 2013 for eligible expenses incurred at any time in 2014). 
  • Salary Deferral Limit.The $500 carryover does not count toward the $2,500 annual limit on salary deferrals. A participant may carryover $500 from his or her unused health FSA balance from 2013 into 2014, and may also elect to contribute the full $2,500 limit for 2014. 
  • No Grace Period Permitted.A cafeteria plan may not have a grace period in the year into which an amount is carried over under the $500 carryover feature, but may have a grace period for the prior year. For example, a plan may provide for a carryover of $500 from the 2013 plan year to the 2014 plan year. It is acceptable if the FSA had a grace period at the beginning of 2013 (for amounts not used under the 2012 FSA), but it must eliminate the grace period in 2014 (related to 2013 account balances). A health FSA may continue to feature a run-out period, even if a carryover feature is added. 
  • Amendments.Plan sponsors must amend their cafeteria plans by the last day of the plan year from which the carryover is permitted, and the amendment should be retroactive to the first day of that plan year. There is an exception for the 2013 plan year. Plan sponsors that want to amend their health FSA for the plan year beginning in 2013 to allow for the carryover into 2014 must amend their plans no later than the last day of the plan year that begins in 2014 (or December 31, 2014 in the case of a calendar year plan). For non-calendar year plans, the deadline to adopt the amendment to add a carryover feature may go well beyond 2014. For example, if a cafeteria plan has a plan year ending June 30, the plan year that begins in 2013 begins on July 1, 2013 and ends June 30, 2014. That health FSA must be amended by June 30, 2015 to allow for the carryover (the last day of the plan year that begins in 2014).

Special timing rules apply if a health FSA must also eliminate a grace period. To the extent that a plan sponsor wants to add a carryover feature in a health FSA that already has a grace period in place, the plan must also be amended to eliminate the grace period for that year. An amendment to eliminate a grace period must be adopted by no later than the end of the plan year from which amounts may be carried over. Thus, to implement a carryover feature for 2013 accounts, a health FSA with a calendar year plan year would have to be amended by the end of 2013 (i.e., the plan year from which amounts may be carried over) to eliminate the upcoming grace period. 

  • Notice Required.If plan sponsors want to adopt the carryover feature, they will have to notify participants about the new feature. It may be necessary to provide the notice to participants in advance of the deadline to adopt a plan amendment. For example, if plan sponsors want to amend their plans in 2013, they have until the end of 2014 to adopt the amendment (for calendar year-end plans, and as long as a grace period is not also being eliminated). However, participants should be notified as soon as possible about the carryover feature since it will impact their 2013 balances, and the amount available for reimbursements in 2014.

    Employers that adopt the carryover for 2013 balances, and currently have a grace period in place, will want to communicate the change clearly and expeditiously. This is because participants may be planning on using more than $500 of their 2013 health FSA balance for expenses they are planning to incur during the 2014 grace period, which will have to be eliminated.

Issues to Consider

As plan sponsors contemplate this new rule and how it impacts their benefit plans, there are several issues to consider:

  • Impact on HSA participation. Employees that are covered by "general purpose" health FSAs, which generally permit the reimbursement of any eligible medical expense, are not eligible to make contributions to an HSA because the FSA coverage is considered disqualifying, non-high deductible health plan (HDHP) coverage. The Notice does not address how the $500 carryover impacts an employee who elects to be covered under a HDHP for the plan year into which an amount is carried over, and thus also wants to make contributions to an HSA for that year. Based on the available guidance concerning HSAs and health FSA grace periods, such a carryover may cause the employee to be ineligible for an HSA.

    Although the IRS has not yet addressed these issues related to the new carryover feature, available guidance related to grace periods and their impact on HSAs may provide plan sponsors with some potential solutions. For example, plan sponsors may want to consider adding an opt-out provision related to the carryover for such employees wanting to make contributions to an HSA. Alternatively, plan sponsors may want to consider converting the carryover amount to a limited purpose HSA-compatible FSA that may include: (i) a limited-purpose health FSA (i.e., a health FSA that reimburses only dental, vision, and/or preventive care expenses); (ii) a post-deductible health FSA (i.e., a health FSA that reimburses medical expenses only if incurred after the Code §223(c)(2)(A)(i) minimum annual deductible has been satisfied); or (iii) a combination limited-purpose and post-deductible health FSA. Again, these options have not yet been addressed by the IRS specifically related to the carryover feature so we strongly urge plan sponsors to consult with their benefits counsel before proceeding. 
  • Impact on COBRA obligations. Another issue is how the new carryover rule affects COBRA. Generally, health FSAs are considered group health plans and are subject to COBRA obligations. Any unused amounts remaining in an employee's health FSA as of termination of employment and eligibility under the health FSA may be forfeited, unless the employee elects COBRA coverage, subject to certain exceptions. One such exception limits COBRA coverage available under a FSA that is an "excepted benefit" (i.e., the health FSA limits the maximum amount that may be reimbursed and other major medical coverage is available -- see our further discussion below). COBRA is required only if the participant has an underspent health FSA. In that situation, he or she must be offered COBRA through the end of the plan year of the qualifying event.

    The Notice provides only that any unused amounts remaining in an employee's health FSA at termination of employment is forfeited unless that employee elects to continue participation in the health FSA by electing COBRA. The Notice does not address how to handle an employee's (or other qualified beneficiary's) COBRA election under a health FSA that includes a carryover provision. While it appears, based on the IRS' statement in the Notice, that qualified beneficiaries under COBRA may benefit from the carryover, at least to some extent, it is not clear how qualified beneficiaries should benefit under COBRA from a carryover, or for how long. IRS guidance on this issue is needed. 
  • Excepted Benefits Under HIPAA. A health FSA will qualify as an "excepted benefit" under HIPAA and the Patient Protection and Affordable Care Act of 2010 (PPACA) if the maximum amount that may be reimbursed under the health FSA is limited to the greater of (i) two times the participant's salary reduction, or (ii) the participant's salary reduction plus $500. The employer must also make other major medical coverage available to participants. For example, a health FSA is an excepted benefit if the plan sponsor does not make any contribution to the health FSA or does not contribute more than $500 to the health FSA and other major medical coverage is available. However, it is not clear how adding a carryover feature will impact certain FSAs (e.g., one with employer contributions), and if it could cause the health FSA to fail to meet the exception.

    Many typical health FSAs accept only employee salary deferral contributions and will be excepted benefits, even if the carryover feature is implemented. If a health FSA does not qualify as an excepted benefit, however, the health FSA is subject to HIPAA's special enrollment and other portability rules. A health FSA that does not qualify as an excepted benefit is also subject to many of PPACA's mandates.

What now?

To determine whether to amend health FSAs to allow for the $500 carryover, plan sponsors should consider:

  • Whether the plan should be amended for 2013 or for 2014 to provide for the carryover. If a plan sponsor decides to implement the carryover for 2013, it should immediately determine how to communicate the change to employees, and make sure that the plan is amended to eliminate the grace period for 2014, if any. Plan sponsors need to be cognizant of how such a change will affect their employees that will have more than $500 in their health FSA and expect to utilize that balance in the grace period; 
  • The impact this might have on individuals who are currently contributing to a health FSA but may elect coverage under a HDHP and wish to start participating in a HSA; and 
  • How this rule impacts terminated employees and the plan's COBRA obligations.

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.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Heather Abrigo
 
In association with
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Emails

From time to time Mondaq may send you emails promoting Mondaq services including new services. You may opt out of receiving such emails by clicking below.

*** If you do not wish to receive any future announcements of services offered by Mondaq you may opt out by clicking here .

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.