Summary: On October 31, 2013, the Internal Revenue Service (IRS) issued Notice 2013 -71 (the "Notice"), which made two significant changes affecting the administration of cafeteria plans under section 125 of the Internal Revenue Code. First, the Notice modifies the proposed regulations under section 125 to add a limited exception to the "use it or lose it" rule for health flexible spending arrangements ("FSAs"). Next, the Notice clarifies the "transition relief" that was provided in the preamble to those regulations allowing certain participants in non-calendar-year plans to make mid-year elections that are necessitated by the Affordable Care Act, even though there may not be a "change in status."
Modifying "Use It or Lose It"
The first change is that employers are permitted to amend plans that provide health FSAs to permit up to $500 of unused credits for a plan year to be carried over and applied toward expenses incurred at any time in the immediately following plan year. The "use it or lose it" rule would not be completely eliminated, however, and any unused credit in excess of $500 (after expiration of any "run-off" period) would still be forfeited. An employer who wishes to do so may also limit the permitted carryover to an amount less than $500.
This new carryover is an alternative to the current "grace period" rule, however, and a health FSA may not provide for both the new carryover and the current grace period. Looked at pragmatically, if a carryover is to be provided at all, the choice is between (a) permitting a carryover of a limited amount (up to $500) that can be applied during the entire following year, or (b) permitting a potentially larger carryover that can only be applied against expenses incurred during a limited period (i.e., 2½-month "grace period").
In order to adopt the new carryover, the written plan document has to be amended to provide for the carryover (and to eliminate the grace period if one is currently provided). The amendment has to be adopted on or before the last day of the plan year from which the amounts will be carried over, but can be retroactive to the beginning of that year provided that the FSA is operated in accordance with the Notice and participants are notified of the new procedure. As a special rule for this year, the Notice permits a new carryover provision to be adopted effective for the plan year beginning in 2013 so long as it is adopted by the last day of the plan year beginning in 2014. If a plan currently provides for the 2½-month grace period, that provision should still be removed by the end of the year beginning in 2013, or, at minimum, the new limitation should be applied in operation, i.e., no amounts over $500 (or lesser amount designated by the employer) should be permitted to be used after the end of the plan year beginning in 2013.
A carryover under the Notice has no effect on the $2500 limitation on salary reductions for the year to which the amount is carried over. Reimbursements for that year could total $3,000 (or more if the plan also provides nonelective credits), the entire amount of which is also required to be available at any time during the plan year, under the uniform coverage rule.
Allowing Mid-Year Elections
In addition to the FSA change, the Notice addressed the problem faced by participants in non-calendar-year plans who may need to modify their health plan elections effective January 1, 2014, as a result of Affordable Care Act changes becoming effective, but who will not be incurring a "change in status" that would allow such a modification to be made. Last December, the preamble to the proposed regulations under section 125 contained a rule allowing certain individuals in similar situations to make cafeteria plan elections related to new health coverage requirements without having incurred a qualifying "change in status." The Notice extends that same ability to all participants in non-calendar-year cafeteria plans through which health plan coverage is provided.
If the individual had elected salary reduction to purchase health plan coverage, he or she is permitted to revoke or change that election once during the 2013-2014 year. If the individual had failed (or declined) to elect salary reduction to purchase health plan coverage, he or she can make a new election covering the remainder of the year. Employers have to amend their plan documents, and may provide more limited ability, such as allowing the elections to be made only during a limited time period.
If you have any questions regarding this Alert, or how the Notice affects you or your employees, please feel free to contact the author of this Alert, Jeffrey Ashendorf, at email@example.com, or any member of FordHarrison's Employee Benefits Practice Group. You may also contact the FordHarrison attorney with whom you usually work.
 The limitation is indexed for inflation, but the IRS has announced, in Revenue Procedure 2013-35, that the limitation will remain at $2500 for years beginning in 2014.