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IRS 'Use it or Lose it' Rule Amended

Employee Benefits

The Internal Revenue Service (IRS) recently issued new guidance on the ‘Use it or Lose it’ rule that applies to health flexible spending accounts (health FSAs). The rule provides employers with the option to allow health FSA participants to carry over up to $500 of unused funds to the next plan year. The amount of the carryover is in addition to amount a participant can elect for the next plan year. For example, beginning in 2013, the Affordable Care Act limited the amount of participant contributions toward a health FSA to $2,500. With the carryover option, a participant may have a total annual election of $3,000 based on a $500 carryover. This recent guidance is intended to encourage employers and their employees to participate in health FSAs by amending the strict rules on the ‘Use it or Lose it’ policy. Employers should review this information to see if it makes sense for their plan and whether to amend their health FSAs for 2013.

A health FSA is a great way to save money because it allows participants to pay for eligible health care expenses not covered by their health plan. The portion of a participant’s paycheck that is put toward a health FSA is taken out before federal income taxes, social security taxes, and in most cases state income taxes. In the past, unused amounts in a health FSA at the end of a plan year (or applicable grace period) would be forfeited.

If an employer chooses to adopt the carryover, then they must amend his or her Section 125 cafeteria plan to allow the carryover prior to the end of the plan year in which the carryover will occur. If applicable, employers must also amend their plans to remove any grace period that applies to the health FSA before the start of the plan year in which the carryover will be available.

Due to the timing late in the year, the IRS has granted special relief for 2013 that allows a cafeteria plan to be amended to adopt the 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 (or by December 31, 2014 for calendar year cafeteria plans). For those wishing to incorporate the carryover option for the 2013 plan year, there is some time left (up until the end of the 2014 plan year). However, it’s important to note that if your plan currently has a grace period, it needs to be eliminated by the end of the 2013 plan year.

There are pros and cons for employers to consider. For example, participants with year-end balances greater than $500 might benefit from the grace period option with a greater cap ($2,500), while those with balances less than $500 might find value in the carryover option. Employers should review employees’ health FSA balances in order to assess which option would be best: either the carryover or grace period, or an FSA with neither of these options.

Regardless of which option employers choose, they should consider working with a provider that can offer the expertise needed to ensure proper implementation.


This website contains articles posted for informational and educational value. Paychex is not responsible for information contained within any of these materials. Any opinions expressed within materials are not necessarily the opinion of, or supported by, Paychex. The information in these materials should not be considered legal or accounting advice, and it should not substitute for legal, accounting, and other professional advice where the facts and circumstances warrant.