Use-or-lose rule modified

On October 31, the Internal Revenue Service announced a change to its rules governing health flexible spending arrangements (FSAs) offered by small business employers. Under the previous rules, employees had to forfeit any unspent funds remaining in a health FSA at the end of the plan year.

The IRS guidance modifies the use-or-lose rule by allowing employers to permit their employees to carry over up to $500 of unused health FSA balances remaining at the end of a plan year. Accordingly, an employer, at its option, is permitted to amend its Section 125 cafeteria plan document to provide for the carryover to the immediately following plan year of up to $500 of any amount remaining unused as of the end of the plan year in a health FSA.

A plan adopting this carryover provision is not permitted to also provide a grace period with respect to health FSAs. Under the grace period rule, in effect since 2005, a Section 125 cafeteria plan may permit an employee to use amounts remaining from the previous year (including amounts remaining in a health FSA) to pay expenses incurred for certain qualified benefits during the period of up to two months and 15 days immediately following the end of the plan year.

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