IRS Modifies “Use-It-or-Lose-It” for Flexible Spending Arrangements

November 2013

In a recent Notice issued by the Internal Revenue Service,1 the IRS modified a long-standing rule regarding the "use-it-or-lose-it" rule applicable to health flexible spending arrangements ("FSAs") under Section 125 of the Internal Revenue Code of 1986, as amended (the "Code"). Employers that sponsor health FSA plans may now elect to permit employees to carry over a maximum of $500 of unused contributions into the following year instead of automatically forfeiting them.

Health FSAs forming part of a cafeteria plan allow participants to pay for qualified medical expenses (such as deductibles and co-payments) on a pre-tax basis. Under Section 125(j) of the Code, the maximum amount that may be available for reimbursement under a health FSA is currently $2,500. This amount is subject to increase from time to time by the IRS to reflect cost-of-living adjustments.

Historically, unused contributions to a health FSA were required to be forfeited to the employer if the participant did not use the benefits by the end of each plan year (commonly known as the "use-it-or-lose-it" rule). A cafeteria plan could provide for a grace period which extends the period for incurring qualified medical expenses until the fifteenth day of the third month after the end of the plan year (i.e., March 15th for calendar year plans); contributions not used by the end of the grace period were forfeited.

The recent Notice permits a cafeteria plan to be amended to allow up to $500 of unused contributions to a health FSA to be paid to participants for qualified medical expenses incurred in the following plan year. A cafeteria plan that adopts this modification cannot also use the grace period rule. In addition, the modification does not affect the amount that can be contributed by participants to health FSAs each year.

In order to adopt the new carryover option, the cafeteria plan must generally be amended on or before the last day of the plan year from which amounts may be carried over to the next year. Participants must also be informed of the amendment. The time for adopting the amendment for plan years that begin in 2013 is extended until the last day of the plan year that begins in 2014.

This Alert is one in a series on the topic of ERISA and employee benefits. For more information on this Alert or other ERISA matters, please contact:

Fred R. Green at +1 212 592 5910 or [email protected]
Irwin A. Kishner at +1 212 592 1435 or [email protected]

© 2013 Herrick, Feinstein LLP. This alert is published by Herrick, Feinstein LLP for informational purposes only. Nothing contained herein is intended to serve as legal advice or counsel or as an opinion of the firm.

1 IRS Notice 2013-71 (Oct. 31, 2013).