Grace Period or $500 Rollover for Flexible Accounts? Take Your Pick

Do you provide flexible spending accounts (FSAs) for your employees? Generally, if the FSAs aren’t emptied out by year-end, the employees must forfeit the unused funds … forever.

Strategy: Amend your FSA plan. Thanks to recent IRS rulings, employers can now provide a “grace period” at the end of the year or allow employees to carry over up to $500 of any remaining balance.

But there’s a catch: You can’t approve both the grace period and the $500 carryover rule. It has to be one or the other.

With a flexible spending account, employees have the ability to set up a fund for qualified medical expenses, including deductibles and co-pays for doctor and dentist visits. A comparable account may be used for qualified dependent care costs. Contributions are made on a pretax basis, so employees save on both income and employment taxes.

Even better, FSA withdrawals to reimburse you for qualified expenses are completely tax free to you. Significantly, most taxpayers don’t qualify for medical expense deductions due to the high floor of 10% of adjusted gross income (AGI) or 7.5%-of-AGI for taxpayers age 65 or older.

FSAs have been around for decades but were always hindered by the “use-it-or-lose it” rule. Finally, the IRS said that employers could establish a 2 1/2 -month grace period. (IRS Notice 2005-86) So funds taken out of your 2015 salary can be used to pay qualified expenses as late as March 15, 2016.

Then the IRS approved the carryover rule. (IRS Notice 2013-71) There’s no time restriction on its use so funds may be carried over indefinitely. Choose the provision that best suits your employees’ needs.

Tip: The maximum contribution allowed to a health FSA in 2015 is $2,550 (up from $2,500). The dependent care FSA contribution limit remains at $5,000.

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