On Friday, March 28, 2014, the IRS issued guidance regarding the FSA $500 Carryover and Health Savings Account (HSA) eligibility, in addition to guidance regarding FSA substantiation/correction of health care expenses.
IRS Chief Counsel Memo No. 201413005 addresses Flexible Spending Account (FSA) carryovers and Health Savings Account (HSA) eligibility.
IRS Chief Counsel Memo No. 201413006 addresses correction procedures for improper FSA payments.
Regarding FSA carryovers, the IRS provided the following clarifications:
1. An individual in a medical FSA is not eligible for an HSA, even if the balance consists solely of carryover or grace period amount.
2. In regards to the carryover, this HSA ineligibility will continue for the entire plan year, even if the balance is exhausted earlier in the plan year.
3. In regards to the grace period, this HSA ineligibility will continue for the length of the grace period, even if the balance is exhausted before the end of the grace period.
4. As an alternative, a medical FSA can be designed to allow an individual to elect that the carryover amount be used as Limited FSA, so that the medical FSA is compatible with the HSA. The carryover amount cannot be transferred into any other non-Health FSA or another cafeteria plan benefit.
5. The medical FSA cannot be designed to allow an individual to elect to use the grace period and have it transfer into a Limited FSA unless the Limited FSA is established for all individuals.
6. A cafeteria plan may design the medical FSA so that any election for high-deductible health plan (HDHP) coverage, which makes an individual HSA eligible, can automatically force the individual into the Limited FSA, including carryover amounts.
7. An individual may decline or waive a medical FSA carryover prior to the start of the new plan year, in order to become eligible for the HSA.
8. During the run-out period for the medical FSA, unused amounts may be used to reimburse any allowed section 213(d) medical expenses incurred prior to the end of the plan year. Any claims covered by the Limited FSA must be timely reimbursed up to the amount elected for the Limited FSA plan year. Any claims in excess of the elected amount may be reimbursed after the run-out period when the amount of any carryover is determined.
Regarding Medical FSA correction procedures for improper payments, the IRS provided the following clarifications:
1. The debit card collection procedures may be applied to improper payments made without a debit card (i.e., traditional paper reimbursement requests).
2. The debit card collection steps (e.g., demand, withholding and offset) can be applied in any order once the card has been deactivated, except for the last step, which is forgiveness of indebtedness. You must apply the steps consistently with all participants. Forgiveness of indebtedness should be the exception, not a routine process.
3. Where the improper payment is treated as a business indebtedness, the proper course of action is to report it as wages on Form W-2 for the year in which the forgiveness occurs.
While these memos indicate the IRS position on these issues, it is important to note the following disclaimer in both documents. 1. This Chief Counsel Advice responds to your request for assistance. 2. This advice may not be used or cited as precedent.