Author: Tracy Morley, XpertHR Legal Editor

November 4, 2013

The US Department of Treasury and the Internal Revenue Service (IRS) issued a new rule that modifies the "use it or lose it" rule for health flexible spending accounts (FSAs) and provides clarification regarding transition relief available for non-calendar year salary reductions. The change to the long-standing "use it or lose it" rule, issued on October 31, 2013, is effective immediately.

"Use It or Lose It"

According to IRS Notice 2013-71, employees faced with forfeiting unused funds in their health FSAs may be eligible to carry over up to $500 of unused funds from one year to the next. Under the previous "use it or lose it" rule, unused FSA funds were forfeited:

  • At the end of the year; or
  • By March 15 of the following year if the employer adopted a grace period.

The carryover option provides an alternative to the current grace period. A plan may not include both the carryover provision and the grace period.

Although the change to the long-standing "use it or lose it" rule is effective immediately, it is not mandatory for employers. In order to adopt the new carryover option, the plan document must be amended to provide for the carryover provision and eliminate any grace period (if one is provided). The amendment must be adopted on or before the last day of the plan year from which the amounts are carried over. The amendment may be effective retroactive to the beginning of that plan year, as long as the plan is operating in compliance with the Notice and as long as participants are informed of the new carryover provision.

There is a special rule for the current 2013 year. A plan may be amended to adopt a 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.

If a plan that currently provides a grace period is being amended to add a carryover provision, the plan must also be amended to eliminate the grace period provision no later than the end of the plan year from which amounts may be carried over.

The carryover of up to $500 does not affect the $2,500 salary reduction limit (indexed for inflation) applicable to each plan year.

Non-Calendar Year Salary Reductions

In general, cafeteria plan elections must be made before the start of the plan year and are irrevocable during the plan year, with limited exceptions, including certain qualifying changes in status.

The availability of coverage through the health insurance marketplace beginning in 2014 is not considered a change in status. However, Notice 2013-71 clarified that employers with non-calendar (i.e. fiscal year) plans may elect to allow employees to make either or both of the following changes regardless of whether there is a qualifying change in status.

  • If an employee elected salary reductions to purchase health plan coverage, he or she may prospectively change or revoke that election during the 2013 plan year.
  • If an eligible employee did not elect a salary reduction to purchase health plan coverage, he or she may elect coverage for the remainder of the plan year.

An employer would have to amend plan documents in order to effect these changes and may require that such elections may only be made during a certain, limited timeframe.