The Internal Revenue Service will now allow an employer-sponsored health flexible spending account (FSA) program to permit the carryover of up to $500 in unused health FSA funds from one year to the next.

IRS Notice 2013-71, issued on October 31, 2013, modifies the “use-it-or-lose-it” rule for health FSAs, which generally requires the forfeiture of amounts that an employee contributes to an FSA if not used to reimburse qualified medical expenses incurred during that year. The change is intended to make health FSAs more attractive to low-to-moderate-income employees who may have been reluctant to contribute, fearing they would be unable to fully use the account and lose any dollars they have contributed.

Currently, there is a narrow exception to the use-it-or-lose-it rule by which a health FSA can extend a limited “grace period” of up to 2½ months after the end of the plan year. If there is a grace period, any qualified medical expenses that are incurred during that time can be paid from any unused amounts left in the FSA at the end of the previous plan year. Funds not used to reimburse expenses incurred during the plan year or the grace period must be forfeited.

The new IRS rule allows a simpler alternative for health FSAs that do not use the current grace period rule. Such health FSAs can now provide that up to $500 of a participant’s unused account balance can be carried over from one plan year to the next without violating the use-it-or-lose-it rule. The carryover amount can be used to reimburse qualifying medical expenses incurred at any time during that next plan year.

In addition, the change is intended to reduce incentives for unnecessary spending, such as the common phenomenon of a year-end rush by health FSA participants to use up their health FSA accounts on such items as eyeglasses. A simple rule to permit the carryover of up to $500 to the subsequent year should help allow more employees to make full use of their health FSAs to reimburse necessary healthcare expenses.

Carryover amounts do not count against or otherwise affect the total annual amount that an employee can contribute to a health FSA, which is capped by the Affordable Care Act at $2,500.

The new alternative is available immediately, but the employer must choose to offer the carryover option, and cannot offer both the carryover option and the grace period at the same time. Employers will, therefore, need to amend their health FSA documents to provide for the carryover option and eliminate any FSA grace period. A written amendment must be adopted on or before the close of the last day of the plan year from which amounts may be carried over. Under a transition rule, to permit carryovers from 2013 into 2014 most employers will need to amend their health FSAs by the end of 2014.

Attorneys in Ballard Spahr’s Employee Benefits and Executive Compensation Group regularly advise on the administration, operation, and revision of employee health benefits, including health FSAs. If you have questions about the new carryover option or need assistance preparing the necessary amendment to your FSA documentation, contact Kurt R. Anderson at 215.864.8432 or, or Diane A. Thompson at 424.204.4334 or