IRS Relaxes Rules for Health Care FSAs

By Ken Berry
 
Flexible spending accounts (FSAs) used for health care expenses just became slightly more flexible. On October 31, the IRS announced that employers can modify the "use-it-or-lose it" rule frequently resulting in a loss of FSA funds (Notice 2013-71).
 
The rule has been a bone of contention ever since FSAs were introduced in 1978. Essentially, with an FSA, an employee can allocate a portion of his or her salary to an FSA used for qualified health care expenses without paying taxes on those allocations. Beginning in 2013, the annual amount of contributions to a health care FSA is limited to $2,500. However, any portion remaining in the account at the end of the year is forfeited. 
 
Thus, this "use-it-or-lose-it" rule forces employees to make a calculated estimate of their qualified expenses for the year. If they overcompensate and don't pay out all the funds, the excess amount is gone . . . forever.
 
The IRS loosened the rules in 2005 by allowing employers to institute a "grace period" of two and a half months for employees to use FSA funds before they were forfeited. For instance, an employee would have until March 15, 2014, to pay out funds set aside for the 2013 plan year. Now employers can provide another sort of flexibility. Under the new Notice, an employer may permit FSA participants to carry over up to $500 of their unused balance in a health care FSA to the following year.
 
"Across the administration, we are always looking for ways to provide added flexibility and commonsense solutions to how people pay for their health care," said Secretary Jacob J. Lew in a prepared statement. "Today's announcement is a step forward for hardworking Americans who wisely plan for health care expenses for the coming year."
 
The Notice is effective immediately, so the carryover provision may still be adopted for the 2013 plan year. In addition, the existing option allowing a year-end grace period remains in place. But a health care FSA can't have both a carryover and a grace period: Employers must choose one or the other.
 
FSAs continue to grow in popularity in the workplace. The government says an estimated fourteen million families now participate in health care FSAs. 
 
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