Ever since cafeteria plans, also called Section 125 plans, became available in 1978, employers have complained about the rigidity of these plans. Specifically, they were troubled by the fact that, when employees did not use all of the funds in their accounts by the end of the year, those funds had to be forfeited.

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IRS Adds an Attractive Option to
Flexible Spending Accounts

2. Background: Ever since cafeteria plans, also called Section 125
plans, became available in 1978, employers have complained about the
rigidity of these plans. Specifically, they were troubled by the fact
that, when employees did not use all of the funds in their accounts by the
end of the year, those funds had to be forfeited. The main concerns have
been:
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• The restriction discourages participation, particularly among lower
paid workers who could not abide the thought of throwing away
hard-earned money if they failed to drain their health flexible
spending accounts (FSAs) by the end of the year,
• To avoid forfeiting their unused funds, employees rushed to incur
unnecessary health services at the end of the year.
• Plan administration could be simplified by easing the restriction.
Later, when health savings accounts became available, FSAs lost some of
their appeal. This is because health savings accounts, in conjunction with
high-deductible health plans, allow for long-term accumulation of savings
for health expenditures, a feature which many employers found
attractive.

3. Grace Period Option
In 2005, the IRS relented to these critics by allowing for a 2-1/2-month
"grace period" after the end of the plan year, when employees could use
up remaining FSA funds. For employers who made the election to allow
the grace period, this added flexibility was welcome. Now, in another
positive change, participants in FSA accounts will be able to carryover
$500 of FSA funds, to the following year. This is effective currently, for
2013, but the carryover is not automatic, it must be elected. More about
this below.
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Also, there's a catch. Your plan cannot allow for the $500
carryover and the 2-1/2 month grace period. You must choose one or the
other, or neither. And, the choice you make applies to all your
participating employees. (IRS Notice 2013-71).
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4. Employers who opted to allow for the 2-1/2-month grace period option
had to amend their plans. In the same way, if you choose to adopt the
new $500 carryover, you must make that election, it is not automatic.
Suppose you already have the 2-1/2 month grace period in effect, and
wish to change your plan to allow for the $500 carryover instead. If this is
your situation, you must address this issue when you amend your plan to
adopt the carryover.
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Keep in mind, last year the IRS
capped employee FSA salary
reductions at $2,500, a limit which
will be adjusted annually for
inflation.

5. Amendment Deadlines
As for timing, here's what the IRS says:"the amendment must be adopted
on or before the last day of the plan year from which amounts may be
carried over and may be effective retroactively to the first day of that plan
year" (assuming you comply with the rest of the guidance included in the
notice). However, because of the newness of this change, an exception is
made for 2013. If you choose to adopt the carryover for a plan which
began in 2013, you may amend your plan to make the choice at any time
up to the last day of the plan year that begins in 2014.
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6. Another point to note, the $500 amount is simply an upper limit. You
could amend your plan to provide for a carryover limit below
$500, although it's hard to imagine a scenario in which that would be
advantageous.
The amount available for carryover treatment includes what's left after
claims have been paid during the plan year, as well as reimbursements
during the "run-out period." The IRS defines the "run-out period" as the
period immediately after the end of a plan year, during which a
participant can submit a claim for reimbursement (for funds already spent
but not yet claimed). This is not to be confused with the grace period of 2-
1/2 months when employees can still actively spend funds in their FSA
accounts from the prior plan year.
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7. Carryover Illustration Direct from the IRS
Here is one of four examples, all of which are available at IRS Notice 2013-
71, to help shed more light on this new provision.
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In November 2014, "Participant A" elects a salary reduction amount of $2,500 for 2015. By
December 31, 2014, A's unused amount from the 2014 plan year is $800. On February
1, 2015, A submits claims and is reimbursed with respect to $350 of expenses incurred
during the 2014 plan year, leaving a carryover on March 31, 2015 (the end of the run-out
period) of $450 of unused health FSA amounts from 2014.
The $450 amount is not forfeited; instead, it is carried over to 2015 and available to pay
claims incurred in that year so that $2,950 (that is, $2,500 + $450) is available to pay claims
incurred in 2015. A incurs and submits claims for expenses of $2,700 during the month of
July 2015, and does not submit any other claims during 2015. A is reimbursed with respect
to the $2,700 claim, leaving $250 as a potential unused amount from 2015 (depending
upon whether A submits claims during the 2015 run-out period in early 2016).
If you do decide to amend your plan to allow for carryovers, begin talking to
your employees about the change as soon as possible. The added flexibility
may be a huge advantage, but only if employees understand the process well
enough to use it to their benefit.
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