The IRS has modified the “use-it-or-lose-it” rule for health flexible spending arrangements.

At the plan sponsor’s option, employees participating in a health flexible spending arrangement (health FSA) may be allowed to carry over to the next plan year up to $500 of unused amounts remaining at year-end, according to Notice 2013-71 and an accompanying fact sheet. Prior to this announcement, any amounts that were not used by year-end were forfeited.

Health FSAs are benefit plans established by employers to reimburse employees for healthcare expenses, such as deductibles and co-payments. These plans are usually funded by employees through salary reduction agreements, although employers may contribute as well. Qualifying contributions to, and withdrawals from, health FSAs are not subject to tax.

Unused health FSA contributions left over at the end of a plan year have historically been forfeited to the employer. A plan can, but is not required to, provide an optional grace period immediately following the end of each plan year. The grace period would extend the period for incurring expenses for qualified benefits to the 15th day of the third month after the end of the plan year (March 15 for a calendar-year plan).

For a health FSA to be a qualified benefit under a cafeteria plan, the maximum amount available for reimbursement of incurred medical expenses of an employee, the employee’s dependents and any other eligible beneficiaries with respect to the employee cannot exceed $2,500 per year. This maximum is effective for tax years beginning after Dec. 31, 2012.

The new notice provides that an employer, at its option, can amend its cafeteria plan document to provide for the carryover to the immediately following plan year of up to $500 of any amount in a health FSA remaining unused as of the end of the plan year. The notice also clarifies that the carryover does not count against or otherwise affect the next year’s salary reduction limit. Any unused amount in excess of $500 will be forfeited.

The notice provides that the plan sponsor can specify a lower amount as the permissible maximum carryover amount or can decide not to allow any carryover at all.

For a cafeteria plan offering a health FSA to adopt this new carryover provision, the plan must be amended on or before the last day of the plan year from which amounts may be carried over. The new provision may be effective retroactively to the first day of that plan year.

However, 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. As a result, some plans may be able to put the carryover option into effect for 2013.

©2013 CPAmerica International