IRS Now Allows Employees to Carryover Up to $500 of Unused FSA Contributions
posted Nov 6, 2013 by KLR in the Business Blog
A Flexible Spending Account, or FSA, is one of the most requested employee benefits around - and for good reason. FSA plans allow for employees to contribute up to $2,500 (indexed for inflation) per year of pre-tax dollars to an account that may be spent on qualifying medical expenses such as deductibles, prescriptions and co-pays. Even though FSA contributions are withheld from employee paychecks over the course of the tax year, the total annual election amount is available for use on January 1st. This allows employees to essentially “borrow” against their FSA and pay it back over the course of the year.
The most frustrating aspects of an FSA account are choosing how much to contribute and then monitoring the account to ensure that the funds are used up by the end of the year. In November or December each year, participants must elect how much they will contribute for the following calendar year. Once the amount has been elected, employees cannot change these amounts. Prior to 2012, most plans required that employees had to use the FSA funds by December 31, or forfeit them back to their employer. To provide relief, some plans allowed for a “grace period” until March 15th of the following tax year (for calendar year plans).
In response to these frustrations, the IRS now allows employers the option to amend their FSA plans to allow for a carryover of unused FSA contributions of up to $500 to December 31 of the following calendar year. The IRS is allowing this election to be applied retroactively to the 2013 tax year, so both employers and employees should review their account balances and plans to determine if they should consider amending their plan for the 2013 tax year. For non calendar year plans, the IRS will allow for certain changes to FSA plans to provide relief to employees for fiscal year plan years beginning in 2013.
Here are some important details of the new provisions for employers and employees to keep in mind:
In order for employees to be able to make this carryover election, their employers must amend their section 125 cafeteria plan to allow for the carryover of FSA plan contributions.
- For the 2013 tax year, this amendment must be done before December 31, 2014.
- The carryover provision must apply to all plan participants.
- Unused contributions cannot be cashed out or transferred to any other taxable or non-taxable benefit.
- The plan cannot allow for both a carryover provision and a grace period provision. Thus employers will have to assess which provision employees prefer before they amend their plans.
If plans already have a provision allowing for a grace period, employers preferring to implement the carryover provision will have to remove the grace period provision by December 31, 2013. The IRS warned that eliminating a grace period provision that was previously allowed may cause some legal concerns to employers.
If an employer elects to amend their plan to allow the carryover provision for the 2013 tax year, employees will still be limited to up to $2,500 of contributions annually (indexed each yea r). If employees do not use all of their FSA contributions during 2013, they may carry over up to $500 of 2013 FSA contributions to 2014. This carryover will not limit the amount of their contributions for the 2014 tax year. Employees should remember that if the carryover provisions apply, they will no longer have the grace period (if previously allowed) available, so they will need to use up all but $500 of their FSA balance by December 31, 2013.
Jane, an employee elects in 2012 to contribute the maximum $2,500 to their FSA for calendar year 2013. Her employer (ABC Corp.) elects in 2013 to retroactively amend their plan document to allow all employees a carryover of up to $500. Jane uses up $2,000 of her FSA during 2013. She may carry over the $500 shortfall and may still elect the maximum $2,500 FSA contribution for 2014. Thus Jane may incur up to $3,000 of qualified medical expenses that will be covered under their FSA for 2014. Any contributions in excess of the $500 that are unused by December 31 will be forfeited to her employer, ABC Corp.
These provisions are a result of public response to the IRS over concerns regarding FSA plans. This new optional provision will help to alleviate concerns over current and future medical spending. Thus, employees will most likely be asking employers to implement these provisions. Employers should begin discussions with the employees now and consult with their attorneys and tax advisors to ensure that plan documents are amended accurately and timely, especially for employers who already offer a grace period provision in their plans. If you are considering adopting this new provision in your section 125 plan please contact any member of the KLR Tax Services team at 888-KLR-8557 or email firstname.lastname@example.org.