On October 31, 2013, the Internal Revenue Service issued Notice 2013-71, which modifies the “use or lose” rule for flexible spending accounts (FSAs) and permits employers to amend their section 125 “cafeteria” plans to allow employees to carry over up to $500 in unused FSA contributions to the next plan year.

Prior to the new guidance, FSA account balances remaining at the end of the plan year could not be carried over and generally had to be forfeited. Under 2005 IRS guidance, some employers have permitted employees to use their FSA contributions to pay qualified expenses incurred during a grace period of up to 2 ½ months following the end of the plan year. In addition, employers also typically employ a “run-out” period in the following year (or following the end of the grace period, if applicable) during which time employees can submit reimbursement claims for expenses incurred during the prior plan year (and any applicable grace period).

Under the new guidance, employers have the option to offer either a carryover of up to $500 or a grace period, but not both. Employers may impose a carryover limit of less than $500, but the same carryover limit must be applied to all employees. The carryover, which must be available to reimburse expenses incurred any time during the plan year to which it is carried over, does not affect in any way the annual $2,500 salary reduction limit.  As a result, employees could have up to $3,000 available annually for reimbursement under an FSA, as the amount carried over is determined after all prior year expenses have been reimbursed.

In general, employers have until the last day of the plan year from which amounts can be carried over in which to amend their cafeteria plans to add the carryover option. In addition, in recognition of the fact that the 2013 plan year will end soon for many cafeteria plans, employers may adopt a carryover provision for a plan year beginning in 2013 at any time by the last day of the plan year that begins in 2014 (e.g., for a calendar year plan, an amendment may be made as late as December 31, 2014 to permit carryover from the 2013 plan year to the 2014 plan year). An employer that currently offers a grace period and wants to change to a carryover must also amend its plan to eliminate the grace period no later than the end of the plan year from which amounts may be carried over.

However, in deciding whether to implement a carryover, employers who offer a high deductible health plan with health savings accounts (HSAs) should keep in mind that the carryover could affect the ability of employees enrolled in such an option to make contributions to their HSA (unless the FSA is converted to a “limited purpose” or post-deductible arrangement).  Since a carryover must be provided to all eligible employees, implementing one may not make sense in these circumstances unless the employer has (or is otherwise willing to put) in place a limited purpose or post-deductible HSA.