IRS Modifies Use-It-Or-Lose-It Rule For Employee Medical Flexible Spending Accounts 

On Thursday, October 31, 2013, the Internal Revenue Service issued Notice 2013-71, relaxing the longstanding “use-it-or-lose-it” rule for employee medical flexible spending accounts (“FSAs”). In addition, for the first time the Notice allows employees to carry forward up to $500 of unused salary reduction amounts to a subsequent cafeteria plan year. The carryover option is not available to employer cafeteria plans that already incorporate the 2½-month grace period rule.
Immediate Action Required to Adopt Carryover Provision for 2013 Cafeteria Plan Year
The Notice went into effect immediately. Employers can adopt the up-to-$500 carryover provision to medical FSAs for the current cafeteria plan year (and/or future cafeteria plan years) by amending their cafeteria plan document on or before the last day of the plan year from which amounts would be carried over. Employers with calendar-year cafeteria plans will need to act quickly in order to amend their cafeteria plan document, and notify participants of the carryover provision prior to December 31, 2013.
Mechanics of the Carryover Provision
Pursuant to the notice, an employer is permitted to amend its cafeteria plan document to provide for the carryover of up to $500 of salary reduction election amounts remaining unused as of the end of the cafeteria plan year in a medical FSA to the immediately following plan year. The carryover of up to $500 from the previous plan year does not affect an employee’s ability to elect salary reduction contributions of up to $2,500 for the current plan year. However, employers adopting this provision must adopt a uniform carryover amount (up to $500) for all employees.
The notice applies a last-in, first-out ordering rule for the application of FSA funds to employee claims for the reimbursement of medical expenses, i.e., all claims incurred during the current cafeteria plan year are required to be reimbursed first from amounts that were credited for the current plan year. Only after exhausting these current plan year amounts may employees be reimbursed for medical claims with unused funds that have been carried over from the previous plan year. Up to $500 in unused FSA funds may be carried over to the following plan year.
Any unused FSA amounts in excess of $500 (or a lower amount specified in the employer’s cafeteria plan document) will be forfeited. Further, any unused amounts remaining in an employee’s medical FSA upon the termination of his or her employment are also forfeited (unless the employee elects COBRA continuation coverage with respect to the medical FSA (if applicable)).
Transition Relief for Non-Calendar Year Cafeteria Plans Beginning with 2013 Plan Year
Beginning with the 2013 plan year, a participant in a non-calendar year cafeteria plan is permitted to make either or both of the following changes in salary reduction elections in connection with his or her medical FSA, without regard to whether the individual has experienced a “change-in-status” event (for purposes of Treas. Reg. § 1.125-4):

1.  A participant may prospectively revoke or change a prior salary reduction contribution election; or
2. A participant may make a prospective salary reduction contribution election despite the fact that he or she had failed to make an election during the regular cafeteria plan enrollment period.