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Client Alert: More Flexible Use-it-or-Lose-it Rule for FSAs

May 20, 2005

In big news for employers who sponsor health or dependent care flexible spending accounts (FSAs) for their employees, the IRS has just made the strict "use-it-or-lose-it" rule a little more flexible. Here's a brief summary of the new rule, which is set forth in Notice 2005-42, issued by the IRS on May 18th:

  • FSAs may now provide for a 2½ month grace period immediately following the end of each plan year (e.g., until March 15 for calendar year plans).
  • Eligible expenses incurred during the grace period may be paid or reimbursed from the unused FSA balance remaining at the end of the immediately preceding plan year.
  • The grace period must apply to all participants.
  • Any balance remaining after reimbursement of all eligible expenses incurred during the plan year and the grace period will be forfeited.
  • Employers may still provide a "run-out" period after the end of the grace period, during which eligible expenses incurred during the plan year and the grace period may be paid or reimbursed.
  • Employers may adopt the new grace period rule beginning with the current plan year by amending the FSA plan document before the end of the current plan year. In other words, a calendar year FSA may apply the new grace period for 2005 (allowing eligible expenses incurred through March 15, 2006 to be reimbursed from the 2005 FSA amount) as long as the plan document is amended by December 31, 2005.

Please feel free to contact us if you have any questions regarding the new rule or if you need assistance with the amendment of your FSA documents.

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