H.R. 1004: Medical FSA Improvement Act of 2011

The Medical Flexible Spending Account Improvement Act of 2011, introduced recently by Reps. Charles Boustany (R-LA), John Larson (D-CT), Erik Paulsen (R-MN) and others, aims to encourage more people to use health care FSAs by eliminating the so-called “use-it-or-lose-it” rule.

The Medical FSA Improvement Act of 2011 amends the IRS Code to allow amounts in FSA (Flexible Spending Arrangements) plans, that are NOT spent for medical care, to be distributed to the participant as taxable income after the close of the plan year.  Previously such unspent amounts were forfeited by the participant to their employers at the end of the plan year (or grace period where one was offered).

The new bill, passed by committee by a 23-6 vote, would allow employees to withdraw up to $500 in taxable cash at the end of the plan year (or grace period). And the withdrawal would have to be made within seven months of the end of the plan year.

The Congressional Budget Office issued a summary regarding the impact of H.R. 1004 on the Federal Government.  In the report, the office states that “. . . . estimates that enacting H.R. 1004 would reduce revenues by about $4 million over the 2012 – 2022 period.”   

In related news:  

Earlier the IRS announced it would consider “modifying” the 28-year-old “use-it-or-lose-it” rule because the new $2,500 cap on FSA contributions limits individuals’ ability to defer large amounts of tax-free compensation into an FSA.  

The IRS guidance (www.irs.gov/pub/irs-drop/n-12-40.pdf) clarifies these aspects of that rule:

• The rule is effective for plan years starting on or after Jan. 1, 2013. The limit does not apply to plan years that begin prior to 2013.
• Employer contributions do not count toward the $2,500 limit.
• The limit is per employee. If a husband and wife both work for the same employer, each may make contributions of $2,500 per year.
• Grace period amounts from 2012 carried into 2013 do not count toward the limit. Plans can provide up to two months and 15 days in which salary contributions may be used by the employee before being subject to the “use-it-or-lose-it” rule, and the carryover does not count against the subsequent plan year’s $2,500 limitation.
• If an employer, due to “a reasonable mistake,” allows an employee to contribute more than $2,500 out of his or her salary, and the mistake is corrected by the employer, the plan will not cease to be a valid plan.