did you know - energy tax incentives act of 2005

3 August 2005
To the employee with an FSA Plan

The IRS recently gave a big break to individuals who participate in employer-sponsored flexible spending arrangements (FSAs). In the past, you faced a tight end-of-year deadline to either spend the funds in your FSA account-or forfeit them. But, thanks to the IRS, you now gets an extra 2 ½ months to spend the funds as long as the FSA plan is amended to allow for the grace period.

An FSA is a reimbursement account under which an employee receives tax-free reimbursements for medical expenses or dependent care expenses. FSAs are commonly used, for example, to reimburse employees for medical expenses not covered by insurance.

Contributions to an FSA are usually made pursuant to salary reduction agreements between the employer and the employee in which the employee agrees to contribute a portion of his or her salary on a pre-tax basis to pay for the FSA benefits.

The IRS's FSA regulations contain a "use-it-or-lose-it" rule. This rule says that contributions made to an FSA in one year cannot be carried over and use to pay expenses in another year. Instead, any unused funds remaining in an FSA account at the end of the year must be forfeited (typically, the forfeitures are used to pay the employer's plan administration expenses).

This rule has often put FSA participants in a bind. If participants kept their contributions low to avoid the possibility of forfeitures, they ran the risk of not having enough money in their account to pay all of their expenses. On the other hand, if the participants made contributions at a higher rate, they might approach the end of the year with excess funds in their account. As a result, they might have to accelerate expenses (e.g., moving up a medical checkup) or incur unnecessary expenses (buying an extra pair of glasses) simply to clear out their FSA account by year-end.

The IRS has announced that it's changing the "use-it-or-lose-it" rule. There will still be an annual deadline for using up your FSA funds. But under the new revised rule, employers can amend their FSAs to provide for a grace period of up to 2 ½ months.

For example, suppose an employer changed its FSA to take full advantage of the new rule. Participants would now have until March 15, 2006 to use their contributions made during 2005. In other words, a participant would have 14 months and 15 days (the 12 months in the current plan year plus the grace period) to use the funds before they were forfeited under the "use-it-or-lose-it" rule.

You will want to check with your employer to see the current status of your plan.

If you want more details on the new rule-or on FSAs in general-please contact me at (951) 775-7944.

Sincerely,

Douglas A. Sevy