New government efforts to relax the flexible spending account “use it or lose it” rule could create complications for FSA holders and FSA plan sponsors.[@@]

Employees who belong to FSAs may have to think harder about how to handle claims for products or services purchased early in the plan year, and FSA administrators may have to think harder about how to handle claims paid with debit cards early in the plan year, according to Dan Rashke, chief executive of Total Administrative Services Corp., Madison, Wis., a benefits administration firm.

The FSA is a kind of personal health spending account.

Employees who belong to an FSA plan can cut their income taxes by contributing “pre-tax” income to FSAs. FSA holders can use account funds only to pay for medical services, prescription drugs or other products or services that qualify for FSA reimbursement under the complicated federal laws and regulations that govern FSAs. Until recently, FSA holders had to spend every penny of account funds by the end of the plan year. Employers were supposed to take back any funds left in the FSAs after the end of the year.

In May, the Internal Revenue Service tried to make life easier for FSA holders by releasing a guidance, Notice 2005-42, that gives FSA holders 2.5 months after the end of the plan year to spend FSA funds.

Before the IRS created the new “grace period,” employees had an easy time deciding which plan year to submit eligible expenses against, Rashke says.

Now, employees in FSA plans with plan years that start Jan. 1 will have until March 16 to spend previous-year FSA funds.

Employees will have to decide whether a claim for products or services purchased early in the plan year should draw on current-year FSA funds or previous-year FSA funds, Rashke says.

Administering grace periods also could cause problems for FSA holders who use debit cards to draw on FSA funds, because debit cards are not capable of splitting claims in half, Rashke says.

“It’s an all or nothing proposition for the debit cards,” Rashke says. “Administrators will need to develop unique and potentially complicated systems to get around this situation.”

But Rashke says the most important improvement that could be made would be passing legislation that would let FSA holders carry funds over to the following year.

Even if Congress eliminates the FSA use-it-or-lose-it rule, FSAs will continue to be different from the new health savings accounts.

HSAs are more portable, but FSA holders can combine their FSA plans with conventional low-deductible or medium-deductible health coverage, Rashke says.