As we move into the holiday season, there is much to be thankful for in the recent IRS announcement regarding changes to the “Use or Lose” rule. Employers and flexible benefit administrators all received wonderful news yesterday (October 31, 2013) that the IRS is amending the “Use or Lose” rule to allow participants in a health flexible spending account (health FSA) to carryover up to $500 of unused funds into the next plan year. This change comes after several years of effort on the part of third party administrators, including Discovery Benefits, ECFC members and others in the industry to convince the IRS of the benefits associated with allowing a carryover. Thanks to these efforts, the IRS agreed that it was appropriate to modify the “Use or Lose” rule to permit a carryover of up to $500 of unused amounts in a health FSA into the next plan year. We anticipate there will be renewed and even new interest in health FSA participation due to this rule change. The “Use or Lose” rule has been a prominent reason why participation in the health FSA is typically only 20%. With these changes, we expect to see an increase in health FSA participation that has the potential to significantly reduce employer payroll taxes and help increase employee take-home pay, thereby creating a win-win situation for both employers and employees. Here is a summary of what was included in IRS Notice 2013-71: The carryover is available at the employer’s option and is in lieu of the grace period. A plan cannot have both the carryover and the grace period. The carryover applies only to the health FSA and is not available for the dependent care FSA. The employer has flexibility in how much it will allow a participant to carry over into the next plan year. The maximum allowed is $500, but an employer could choose to allow a lesser amount, as long as the same carryover limit applies to all health FSA participants. An employer also has flexibility in whether it wants to allow the carryover, the grace period or neither option. Employers wishing to adopt the carryover option will need to amend their plan to include the carryover and remove the grace period, if applicable. Employers who offer a plan without a grace period may amend their 2013 plan to include the carryover into 2014. The plan would need to be amended by the last day of the 2014 plan year retroactive to the first day of the 2013 plan year. Employees will need to be informed of the carryover provision during the 2014 plan year open enrollment. Employers who currently offer a grace period and wish to allow the carryover will need to wait to amend their plans in 2014 to allow the carryover into the 2015 plan year. At the same time, the plan would be amended to remove the grace period from the 2014 plan year. Employees will need to be informed of this change during the 2014 plan year open enrollment. The carryover does not count against the $2,500 salary reduction limit. An employee could carryover $500 (or if less, the unused amount or employer selected amount) and still elect $2,500. The amount that may be carried over is equal to the lesser of: 1) any unused amounts from the prior plan year after the end of the prior plan year’s run-out period; or 2) $500 or the amount specified in the employer’s plan document if less than $500. Any amounts that remain in the participant’s health FSA after the carryover has been made will be forfeited. In addition, any unused amounts remaining in an employee’s health FSA at termination of employment is forfeited unless that employee elects to continue participation in the health FSA by electing COBRA. The carryover option does not permit or allow unused amounts in the health FSA to be cashed out or converted to any other taxable or nontaxable benefit. How are reimbursements handled when there is a carryover, you ask? Well, the IRS pondered this as well and provided the following guidance: For plans offering the carryover option, a participant’s unused health FSA balance may be used for expenses incurred in the prior plan year as long as the reimbursement request is made during the plan’s prior year run-out period. In addition, carryover amounts from the prior plan year are available to reimburse current plan year claims. Health FSA salary reduction amounts for the current plan year continue to be available for claims incurred in the current plan year only. Any unused amounts from the prior plan year that are used to reimburse current year expenses: 1) will reduce the amounts available to pay prior year expenses during the run-out period; 2) must be counted against the permitted carryover; and 3) cannot exceed the permitted carryover. For “ease of administration,” the IRS provided this as an option: reimbursement requests for expenses incurred in the current plan year are considered reimbursed first from the current plan year salary reductions and once those funds are exhausted, are considered to be reimbursed from the carryover amounts from the prior plan year. We are very excited about the added flexibility in plan design options available to employers for cafeteria plans. During the renewal process we will be communicating with our clients about the options and are available to help answer any questions about this positive change. Please contact our Account Management team with any questions you might have concerning this information.