On October 31, the U.S. Department of the Treasury and the Internal Revenue Service (IRS) issued a notice modifying the longstanding “use-or-lose” rule for health flexible spending arrangements (FSAs). To make health FSAs “more consumer-friendly and provide added flexibility,” the updated guidance permits employers to allow plan participants to carry over up to $500 of their unused health FSA balances remaining at the end of a plan year. According to an IRS “Fact Sheet” accompanying the notice, some plan sponsors may be eligible to take advantage of the option to adopt a carryover provision as early as plan year 2013.
Currently, plan sponsors have the option of allowing employees a grace period that allows them to use amounts remaining unused at the end of a year to pay qualified FSA expenses incurred for up to two and a half months following year-end. Under this new change, an employer, at its option, is permitted to amend its § 125 cafeteria plan document to provide for the carryover to the immediately following plan year of up to $500 of any amount remaining unused as of the end of the plan year in a health FSA. Furthermore, the carryover of up to $500 does not count against or otherwise affect the indexed $2,500 salary reduction limit applicable to each plan year.
The existing option for plan sponsors to allow employees a grace period after the end of the plan year remains in place. However, a health FSA cannot have both a carryover and a grace period: it can have one or the other or neither.