The Treasury Department and the IRS have issued guidance modifying the long-standing “use-or-lose” rule for health flexible spending arrangements (FSAs). The modifications permit Section 125 cafeteria plans to be amended to allow plan participants to carry over up to $500 of their unused health FSA balances remaining at the end of a plan year. In addition, 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.

An employer may adopt the carryover provision authorized in the guidance for the current cafeteria plan year (and/or subsequent cafeteria plan years) by amending the Section 125 cafeteria plan document in the manner and within the time frames described in the guidance.

In conjunction with the release of this guidance, a fact sheet has been released that generally discusses what is a health flexible spending arrangement (FSA) and how health FSAs work. It also discusses what has changed as a result of the modification of the use-or-lose rule and how the modification of the rule helps consumers. Finally the statement discusses the options for employers and plan sponsors who choose to allow employees to carry over up to $500 from the health FSAs.

The guidance also clarifies the scope of the transitional rule applicable to noncalendar-year plans beginning in 2013 for participant changes in salary-reduction elections under health plans provided through these cafeteria plans. These clarifications may be applied on or after December 28, 2012.

Treasury Press Conference

With the announcement of the modification to the “use-or-lose” rule, an employer now has effectively three separate options, a senior Treasury official stated during an October 31 press conference following release of Notice 2013-71.

These are:

  • The employer may amend its plan to introduce the carry-forward of up to $500; or
  • The employer may use the Section 125 grace period rule under which an employee can use amounts remaining from the previous year (including amounts remaining in a health FSA) to pay qualified expenses incurred during the period of up to two months and 15 days immediately following the end of the plan year; or
  • the employer may choose neither of the above options.

The Treasury official also clarified that employers wanting to adopt the $500 carry-forward in their 2013 plans could do so for plans whose plan years began as early as January 1, 2013. “[The employer] could adopt this carry-forward by amending its plan no later than December 31, 2014. The amendment would be effective retroactively,” the official explained. “We want to give them enough time to amend their plan. We’re giving them extra time to amend on a retroactive basis.”

“An employer can’t combine a grace period and a carry-forward for the same plan year,” the senior Treasury official clarified. He also cautioned that employers with plans that currently include a grace period might face certain legal constraints preventing them from immediately replacing a grace period with a $500 carry-forward. “Employees may be counting on a grace period once they’ve already been told it’s there, perhaps assuming they’ll incur some qualifying expense during the grace period,” he explained.