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Flexible Spending Account Carryovers of Up to $500 Permitted

Filed under Office & HR.

An employee benefit favorite, flexible spending account (FSA) plans make it possible for employees to use pretax dollars to pay for qualifying health care expenses such as co-pays and prescription drugs. A recent law change is sure to increase the popularity of this employee benefit—the “use-it-or-lose-it” rule that required employees to use up balances in FSAs by year-end or forfeit the amount remaining in the account is revised to allow carryovers of up to $500 in unused funds to the next year.

Employers may choose to offer employees the benefit of participating in an FSA through a cafeteria plan. Employees’ payroll deductions (and employers’ contributions in some cases) fund the account with pretax dollars. The funds from the account are then used during the year for reimbursement of certain types of expenses. The amounts contributed to the FSA qualify for federal income, Social Security, and Medicaid tax breaks, plus state income tax breaks in many states.

For 2013, the maximum pretax amount that an employee can contribute in a year for a health care FSA is $2,500.

Major Drawback of Forfeiting Unused Funds in FSAs Lifted

The amounts contributed to an FSA are to be used during the year for eligible expenses. So what happens to any funds remaining unused in the FSA at year-end? Before the IRS revised the rules on October 31, 2013, if a balance was left in an employee’s FSA at the end of the year, generally, it was forfeited, with one exception: In 2005, the “use-or-lose-it" rule was modified to allow employers the option of adopting a two-and-a-half month grace period during which employees could use the funds remaining in the FSA after year’s end.

New rules allow carryover. Under new IRS rules, employers may amend their cafeteria plans to allow up to $500 of any amount remaining unused in an FSA as of the end of the plan year to be carried over to the following plan year.

The amount carried over may be used to pay or reimburse qualified expenses incurred during the full plan year to which it is carried over. Employers also have the option of amending a plan to provide that an amount lower than $500 is able to be carried over to a subsequent year.

Keep in mind that an employer is not required to allow any or all of this carryover—it’s purely optional.

Warning

It’s important to note that if your FSA plan allows the carryover, it cannot also allow for the two-and-a half month grace period after the year’s end and vice-versa. Only one is permitted. Therefore, if you already have an FSA plan in place with a two-and-a-half month grace period feature, you will have to change your plan to eliminate the grace period if you wish to allow for the carryover option instead.

Annual contribution amount limit unaffected. Effective for plan years starting January 1, 2013, the Patient Protection and Affordable Care Act, established $2,500 as the maximum pretax amount that an employee can contribute in a year for a health care FSA (this amount may be indexed for inflation). The $500 permitted carryover amount does not impact the annual contribution amount.

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