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New use-it-or-lose-it FSA option

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in Small Business Tax,Small Business Tax Deduction Strategies

On Halloween, the IRS announced that employers are able to modify the long-standing use-it-or-lose-it rule bedeviling flexible spending accounts (FSAs) used for health care ex­­penses. (IRS Notice 2013-71, 10/31/13) The onerous rule requires em­­ployees to forfeit FSA funds if they don’t use those amounts by the end of the plan year.

Strategy: Don’t wait until 2014 to implement changes for your business. The new Notice is effective immediately, so you may offer this op­­tion to employees for the 2013 plan year.

Under the new guidance, em­­ployees can carry over up to $500 in un­­used funds to the next plan year.   

Here’s the whole story: An estimated 14 million families participate in health care FSAs. Frequently, FSAs are offered in conjunction with other employer-provided benefits as part of a cafeteria plan. They are commonly funded by employees through voluntary salary reduction contributions.

FSA contributions, which are limited to $2,500 beginning in 2013, aren’t subject to either federal in­­come tax or payroll taxes. So it’s a win-win situation for employees and employers.

For nearly 30 years, employees have been haunted by the use-it-or-lose-it rule, although most forfeitures are less than $500. The IRS recently loosened up things slightly by enabling em­­ployers to offer a 2½-month grace period at the end of the year. For instance, an employee may have until March 15, 2014, to empty out funds set aside in 2013.

Thanks to the new ruling, em­­ployers may now allow plan participants to carry over up to $500 of their unused health FSA balance at the end of a plan year. Employees will be able to use carryover funds to reimburse qualified medical expenses incurred during the following year.

The rule for the 2½-month grace period rule also remains in place, but there’s a catch: You can’t combine it with the carryover provision. In other words, you have to choose one or the other.

Tip: Employers aren’t required to use either the grace period or the carry­­over rule.

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