1. FURTHER MODIFICATION OF USE-OR-LOSE RULE
The public comments argued for additional flexibility with respect to the operation of the use-or-lose rule for a number of reasons. These included the difficulty for employees of predicting their future needs for medical expenditures, the desirability of minimizing incentives for unnecessary spending at the end of a year or grace period, the possibility that lower- and moderate-paid employees are more reluctant than others to participate because of aversion to even modest forfeitures of their salary reduction contributions, and the opportunity to ease and potentially to simplify the administration of health FSAs. In light of these comments, the Treasury Department and the IRS have determined that it is appropriate to modify the use-or-lose rule to permit the use of up to $500 of unused amounts in a health FSA in the immediately following plan year.
Accordingly, an employer, at its option, is permitted to amend its § 125 cafeteria plan document to provide for the carryover to the immediately following plan year of up to $500 of any amount remaining unused as of the end of the plan year in a health FSA. The carryover of up to $500 may be used to pay or reimburse medical expenses under the health FSA incurred during the entire plan year to which it is carried over. For this purpose, the amount remaining unused as of the end of the plan year is the amount unused after medical expenses have been reimbursed at the end of the plan’s run-out period3 for the plan year. In addition to the unused amounts of up to $500 that a plan may permit an individual to carry over to the next year, the plan may permit the individual to also elect up to the maximum allowed salary reduction amount under § 125(i). Thus, the carryover of up to $500 does not count against or otherwise affect the indexed $2,500 salary reduction limit applicable to each plan year. Although the maximum unused amount allowed to be carried over in any plan year is $500, the plan may specify a lower amount as the permissible maximum (and the plan sponsor has the option of not permitting any carryover at all).
A plan adopting this carryover provision is not permitted to also provide a grace period with respect to health FSAs. Nor is the plan, for any plan year, permitted to allow an individual to salary reduce for qualified health FSA benefits more than the indexed $2,500 salary reduction limit or permitted to reimburse claims incurred during the plan year that exceed the applicable indexed $2,500 salary reduction limit (and any nonelective employer flex credits) plus the carryover amount of up to $500. If an employer amends its plan to adopt a carryover, the same carryover limit must apply to all plan participants. A § 125 cafeteria plan is not permitted to allow unused amounts relating to a health FSA to be cashed out or converted to any other taxable or nontaxable benefit. Unused amounts relating to a health FSA may be used only to pay or reimburse certain § 213(d) medical expenses (excluding health insurance, long-term care services or insurance, see Prop. Treas. Reg. §1.125-1(q)). With respect to a participant, the amount that may be carried over to the following plan year is equal to the lesser of (1) any unused amounts from the immediately preceding plan year or (2) $500 (or a lower amount specified in the plan). Any unused amount in excess of $500 (or a lower amount specified in the plan) that remains unused as of the end of the plan year (that is, at the end of the run-out period for the plan year) is forfeited. Any unused amount remaining in an employee’s health FSA as of termination of employment also is forfeited (unless, if applicable, the employee elects COBRA continuation coverage with respect to the health FSA).
The uniform coverage rule requires that the maximum amount of reimbursement from the health FSA (including both salary reduction amounts and any nonelective employer flex credits) be available for claims incurred at all times during the period of coverage (properly reduced as of any particular time for prior reimbursements for the same period of coverage). That rule continues to apply to § 125 cafeteria plans adopting the carryover of up to $500.
Use of the carryover option permitted under this notice does not affect the ability of a health FSA to provide for the payment of expenses incurred in one plan year during a permitted run-out period at the beginning of the following plan year (just as a run-out period can also be provided when using the grace period rule). Thus, for plans using the new carryover option, a participant’s unused health FSA balance at the end of the prior plan year may be used (a) for expenses incurred in the prior plan year, but only if claimed during the plan’s run-out period that begins at the end of the prior plan year (in effect retroactively reducing the unused amount as of the end of the prior plan year) or (b) to the extent of the permitted carryover amount of up to $500 from the final prior plan year unused amount, for expenses that are incurred at any time in the current plan year. In contrast, salary reduction or other amounts credited to a health FSA with respect to service in the current plan year may be used only for expenses incurred in the current plan year (unless and to the extent that these current plan year amounts may later be carried over to the following plan year).
For ease of administration, a § 125 cafeteria plan is permitted to treat reimbursements of all claims for expenses that are incurred in the current plan year as reimbursed first from unused amounts credited for the current plan year and, only after exhausting these current plan year amounts, as then reimbursed from unused amounts carried over from the preceding plan year. Any unused amounts from the prior plan year that are used to reimburse a current year expense (a) reduce the amounts available to pay prior plan year expenses during the run-out period, (b) must be counted against the permitted carryover of up to $500, and (c) cannot exceed the permitted carryover.
2. They should begin counting when they became eligible, which is their full-time date of hire.
3. To establish if an employee is eligible for coverage, you may take a reasonable period of time to determine whether the employee works enough hours to meets the plan’s eligibility criteria, which may include a look-back measurement period that is no more than 12 months long. If in reviewing the measurement period, you determine the employee has worked the requisite hours to be eligible for coverage, then up to a 90-day waiting period can be applied but in no case can the coverage start later than 13 months plus a fraction of a month from the employee’s start date.
For Example: Under your group health plan, only employees who work full time (defined under the plan as regularly working 30 hours per week) are eligible for coverage. Terri begins working on November 26, 2014. Terri’s hours are reasonably expected to vary, with an opportunity to work between 20 and 45 hours per week, depending on shift availability. Therefore, you cannot determine at Terri’s start date that he is reasonably expected to work full time. Under the terms of the plan, variable hour employees such as Terri are eligible to enroll in the plan if you determine they are full time after a look-back measurement period of 6 months. You then make coverage effective no later than the first day of the first calendar month after a 90-day waiting period, if the applicable enrollment forms are received. Terri’s 6-month measurement period ends May 25, 2015. Terri is determined to be full time and you notify him of her plan eligibility. If Terri then elects coverage by completing her enrollment form on August 28, 2015, her first day of coverage will be September 1, 2015.
Conclusion: In the above example, because Terri’s coverage becomes effective no later than 13 months from her start date, plus the time remaining until the first day of the next calendar month, the plan is in compliance with the requirement. The measurement period is 12 months or less (and is, therefore, permissible) because you may use a reasonable period of time to determine whether Terri is full time and the waiting period you apply after the end of the measurement period is 90 days or less (and is, therefore, permissible).
D. New Employees: Safe Harbor for Variable Hour and Seasonal Employees
If an employer maintains a group health plan that would offer coverage to the employee only if the employee were determined to be a full-time employee, the employer may use both a measurement period of between three and 12 months (the same as allowed for ongoing employees) and an administrative period of up to 90 days for variable hour and seasonal employees. However, the measurement period and the administrative period combined may not extend beyond the last day of the first calendar month beginning on or after the one-year anniversary of the employee’s start date (totaling, at most, 13 months and a fraction of a month). These periods are described in greater detail below.
a. Initial Measurement Period and Associated Stability Period
For variable hour and seasonal employees, employers are permitted to determine whether the new employee is a full-time employee using an “initial measurement period” of between three and 12 months (as selected by the employer). The employer measures the hours of service completed by the new employee during the initial measurement period and determines whether the employee completed an average of 30 hours of service per week or more during this period. The stability period for such employees must be the same length as the stability period for ongoing employees. As in the case of a standard measurement period, if an employee is determined to be a full-time employee during the initial measurement period, the stability period must be a period of at least six consecutive calendar months that is no shorter in duration than the initial measurement period and that begins after the initial measurement period (and any associated administrative period).
If a new variable hour or seasonal employee is determined not to be a full-time employee during the initial measurement period, the employer is permitted to treat the employee as not a full-time employee during the stability period that follows the initial measurement period. This stability period for such employees must not be more than one month longer than the initial measurement period and, as explained below, must not exceed the remainder of the standard measurement period (plus any associated administrative period) in which the initial measurement period ends.8
An employee or related individual is not considered eligible for minimum essential coverage under the plan (and therefore may be eligible for a premium tax credit or cost-sharing reduction through an Exchange) during any period when coverage is not offered, including any measurement period or administrative period prior to when coverage takes effect.
8 In these circumstances, allowing a stability period to exceed the initial measurement period by one month is intended to give
additional flexibility to employers that wish to use a 12-month stability period for new variable hour and seasonal employees and an
administrative period that exceeds one month. To that end, such an employer could use an 11-month initial measurement period (in
lieu of the 12-month initial measurement period that would otherwise be required) and still comply with the general rule that the initial measurement period and administrative period combined may not extend beyond the last day of the first calendar month beginning on or after the one-year anniversary of the employee’s start date.
5. If an employee who does not work for an educational institution has a break in service because, for example, he/she has unpaid leave or his or her employment terminates, and the employee returns to work or is rehired within 13 weeks, the employee must be treated as a continuing employee, and no new waiting period can be imposed when he/she returns to work. Coverage must resume by the first of the month on or following the date he/she returns to work. If the break in service is more than 13 weeks, the employee can be treated as a new employee, subject to a new waiting period. Coverage does not have to be offered during the break in service period to satisfy play or pay requirements.
Example: Scott terminates his employment with Zero Corp. on June 25, 2017, and is rehired on August 26, 2017. Scott’s coverage must resume as of September 1, 2017, because his break in service was less than 13 weeks.
If the employer wishes, it may use a shorter measurement period for short-term employees. The employer may use a break period equal to the employee's original period of employment (but not less than four weeks) instead of 13 weeks as the break period if the employee has a break in service during the first 13 weeks of employment.
Example: Zero hires John on February 2, 2015. John resigns on March 27, 2015, (after 8 weeks of employment). John is rehired on June 1, 2015, (10 weeks after he resigned). Zero uses the parity rule. Because John’s period of employment was less than his break in service, Zero does not have to offer coverage to John until he completes three full calendar months of employment after his rehire.
The views expressed in this response do not necessarily reflect the official policy, position, or opinions of BenefitMall. This response, to the best of our knowledge is provided for informational purposes. Please consult with a licensed accountant or attorney regarding any legal and tax matters discussed herein.