The IRS recently issued guidance allowing employers to loosen the rules for the administration of their Flexible Spending Arrangements, or FSAs. These plans, also sometimes known as Medical Reimbursement Arrangements, are offered under an employer's cafeteria plan, or Section 125 plan. Under an FSA, participants are permitted to elect to defer a portion of their salary in advance of a plan year, and then use the deferred amount to pay, tax-free, for Qualified Medical Expenses, such as co-pays or deductibles, or noncovered medical expenses.
A hallmark of the FSA has been the "use-it-or-lose-it" rule. To benefit from using tax-free money, a participant must forfeit any unused amount at the end of a plan year. Otherwise, the money is considered "deferred compensation" that is available after the year it is earned, which is forbidden under a cafeteria plan.
The IRS has decided to offer flexibility in the operation of the use-it-or-lose it rule.
The IRS issued Notice 2013-71, at www.irs.gov/pub/irs-drop/n-13-71.pdf, on October 31, 2013. The Notice provides that FSAs under a cafeteria plan may now permit participants to carry over up to $500 of unused amounts remaining at the end of a plan year, to be paid or reimbursed to plan participants for Qualified Medical Expenses incurred during the following plan year. As you may recall, the Affordable Care Act placed a $2,500 limit on the amount a participant can defer for a plan year. This new carryover option will not reduce that limit, so a participant can still defer up to $2,500 in a plan year (depending on a particular plan's terms), and also carry over up to an additional $500 from the prior year.
This new option is exactly that: an optional plan design feature. Notice 2013-71 does not require this carryover provision. Employers need not change their FSAs. Alternatively, an employer may decide to offer the carryover option, but limit the carryover to a lesser amount; $500 is the maximum carryover permitted.
What must an employer do to begin to offer this change in its FSA plan? As with any plan change, the written FSA/cafeteria plan document must be amended, in writing. If the FSA already allows for a "grace period" — permitting a participant to utilize deferred amounts for expenses that occur during the initial months of the next plan year — the employer will need to choose between keeping that grace period provision or dropping it and now offering the carryover provision. The Notice provides that an FSA cannot have both a grace period and a carryover provision.
When can this change become effective? Right now, if you like.
If you simply want to amend your FSA plan to add this carryover option for the 2013 plan year, then you have an extended period, until the end of next year's plan year — 2014 — to amend the plan. However, if you now offer a grace period in your FSA, you also need to remove that provision — by the end of the present plan year. The Notice does not offer the extended amendment period for the grace period revision. This means, then, that a plan that already offers a grace period must execute an amendment now, to remove the grace period and also add the carryover provision, before the end of the 2013 plan year. In addition, the Notice expressly requires that participants must receive notice of this change. Organizational resolutions must also be adopted to direct this change in the plan. Therefore, it may or may not be manageable to amend an FSA for the 2013 plan year.
As always, the maximum amount of reimbursement from the FSA must be available from the first day of a plan year. This "uniform coverage" requirement remains in effect. In addition, the uniform coverage rule applies to the $500 optional carryover provision.
This is a bad time to have to consider yet another change in employer plans, with so much already in play in the health care arena. Employers can elect to add this option in a subsequent plan year, and, as noted above, are not required to change their plan at all. If FSA participation is solid, and if you observe that employees do not leave unused money on the table at year-end, this may not be a change you want to make. Similarly, if your FSA already offers a grace period, and participants are pleased with this option, you may decide to continue that option instead.
If, however, you find that employees are not utilizing the FSA, perhaps it is because it is too difficult to predict medical needs, and there is no room for uncertainty in many employees' budgets. Perhaps you notice that participants are spending their FSA dollars in a final spree at the end of the year on unnecessary items, just to avoid losing the remaining FSA amounts. These concerns could be addressed by adding the new carryover provision.
Time may be short if you want to add the FSA carryover to the 2013 plan year and allow time for issuing notices to employees. If now is not the time, this may be a positive add-on to introduce under an FSA in coming years. We are available to assist in this decision and implementation process.
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