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IRS eases FSA use-it-or-lose-it rule

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The Internal Revenue Service (IRS) has decided to let holders of health flexible spending arrangements (FSA) roll over up to $500 in account balance from one year to the next without worrying about the infamous “use-it-or-lose-it” rule.”

Officials at the IRS, an arm of the U.S. Treasury Department, have discussed the change in IRS Notice 2013-71, and they also talk in the notice about how they will make the change available to workers at employers with non-calendar plan years. The change takes effect immediately.

FSAs give workers a vehicle for setting aside cash to pay for health care expenses without paying income taxes on the cash.

The IRS tried to discourage high-income workers from using FSAs as investment accounts by requiring them to forfeit any unused cash at the end of the plan year. The employers got to keep any cash forfeited.

In 2005, the IRS tried to ease the burden the rule caused by creating a grace period. The grace period rule gave FSA holders the ability to avoid losing FSA cash by using the cash up to two months and 15 days after the end of the plan year.

In 2010, the drafters of the Patient Protection and Affordable Care Act (PPACA) tried to generate revenue to cover part of the cost of PPACA by capping the deductibility of FSA contributions at $2,500 per year.

IRS officials noted in 2012, in Notice 2012-40, that because PPACA capped tax deductible contributions at $2,500 per year, the FSA could no longer be much of a tax shelter for the wealthy.

When officials asked for comments on changing the use-it-or-lose-it rule in that notice, commenters said a change could simplify health FSA administration, and make FSA programs more attractive to low-income and moderate-income workers, who “are more reluctant than others to participate because of aversion to even modest forfeitures of their salary reduction contributions,” officials said.

IRS officials said they believe a $500 rollover cap is appropriate because most FSA forfeitures are for less than $500.

An employer cannot offer a FSA carryover provision and an FSA grace period at the same time.

To adopt the change, an employer must add a carryover provision to the FSA plan document and eliminate any grace period provision, officials said.

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