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IRS Allows Limited Carryover of Unused Health Care FSA Balance

November 5, 2013


Flexible Spending Account ("FSA") arrangements must comply with a stringent "use-it-or-lose-it" rule imposed by Code Section 125. This rule holds that any amounts that have not been reimbursed from a participant's FSA account as of the end of the plan year (or as of the end of a grace period, if the plan so provides) must be forfeited. This is a particularly harsh rule, given the fact that an FSA account is funded by the participant's own contributions made on a salary reduction basis.

After over a decade of discussion, the IRS has at long last acted to relax the use-it-or-lose-it rule for health care FSAs. Specifically, IRS Notice 2013-71, issued on October 30, 2013, allows a health care FSA to provide for the carryover of a limited amount of the unused balances.

The particulars of the IRS Notice are discussed below.

Key Provisions

The key provisions of the IRS Notice are below.

  • A plan can permit up to $500 of the remaining balance of a participant's health care FSA account for a plan year to be carried over to the following plan year.
  • The carryover feature, and the amount of the carryover, is optional. A plan may specify a maximum carryover of less than $500, or not permit any carryover at all.
  • A plan can either provide for the new carryover feature, or the currently permissible 2½ month grace period rule, but not both. For example, a plan permitting a carryover of unused 2013 health FSA amounts to 2014 would not be permitted to have a grace period extending into 2014.
  • The amount carried over into a subsequent year does not reduce the amount that a participant can elect to make on a salary reduction basis for that carryover year. In other words, a $500 carryover from 2013 would not count against or otherwise affect the $2,500 salary reduction limit applicable for the 2014 plan year.

Other Administrative Rules

  • If an employer amends its plan to allow a carryover, the right to the carryover, and the same carryover limit, must apply to all plan participants.
  • The new carryover rule does not apply to dependent care assistance programs.
  • Unused amounts relating to a health FSA cannot be cashed out or converted to any other taxable or nontaxable benefit.

Plan Amendment Issues

An employer may adopt the new carryover feature for the current 2013 plan year, subject to certain restrictions discussed below.

  • In order to utilize the new carryover option, a cafeteria plan must be amended to expressly provide for the carryover feature.
  • In general, a plan may 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 (i.e., by December 31, 2014, in the case of a calendar year plan).
  • However, if a plan provides for the special grace period rule and is being amended to add a carryover provision, the plan must first be amended to eliminate the grace period provision by no later than the end of the plan year from which amounts may be carried over. Therefore, in order for the plan to allow the carryover from the 2013 plan year to the 2014 plan year, the plan must be amended to eliminate the grace period rule by the end of the 2013 plan year.

Unknown Implications to HSA Eligibility

A participant who is eligible for reimbursements under a "general purpose" FSA is not eligible for HSA contributions. In the case of a general purpose health FSA with a grace period feature, a participant with a year-end balance, who does not elect to participate in the FSA for the following year, is nevertheless ineligible for HSA contributions until the first calendar month after the grace period ends (e.g., April 1, in the case of a January 1 through March 15 grace period).

The IRS Notice does not address whether the carryover from a general purpose FSA will restrict a participant's right to an HSA contribution for the carryover year (assuming that the participant declines to participate in the health care FSA for the carryover year). Presumably the carryover would make the participant ineligible, at least until the month as of which the carryover amount is fully reimbursed. Additional IRS guidance as to this matter will be appreciated.

For further information or questions regarding the actions required or the implications of the new health care FSA carryover option, please contact the Schwabe attorney with whom you work or Wally Miller at 541-686-3299 or

IRS rules of practice require us to inform you that any federal tax advice contained in this correspondence is not intended or written to be used, and cannot be used, by the recipient or any taxpayer for the purpose of avoiding tax penalties under the Internal Revenue Code.