Employers Given the Opportunity to Defer Cafeteria Plan and Flexible Spending Account Forfeitures

By Pamela M. Macal

On May 18, 2005, the Treasury issued Notice 2005-42, which allows Plan providers to modify their Section 125 Cafeteria Plans and Flexible Spending Accounts to allow an additional “grace period” of up to two and a half months following the end of each Plan year for the participant to incur additional qualified medical expenses before the “use it or lose it” forfeiture rule applies. Prior to issuing this Notice, qualified medical expenses had to be incurred within the Plan year in order to constitute a reimbursable expense.

According to the Notice issued by the Treasury, the Section 125 Plan document may, at the employer’s option, be modified to provide for a grace period immediately following the end of each Plan year. This grace period must apply to all participants in the cafeteria plan. Qualified medical expenses incurred during the grace period may be paid or reimbursed from the remaining unused benefits or contributions available at the end of the immediately preceding Plan year. The grace period cannot extend beyond the 15th day of the third calendar month after the end of the immediately preceding Plan year.

Section 125 plan may not permit unused benefits or contributions to be cashed-out or converted to any taxable or non-taxable benefit during the grace period. Any unused benefits or contributions remaining in the Section 125 plan after the end of the Plan year may only be used to pay or reimburse qualified medical expenses incurred during the grace period. Employers may continue to provide a “run-out” period after the end of the Plan year or grace period, which provides an additional time period for qualified medical expenses incurred within the grace period to be submitted for reimbursement.

While the new rules issued by the Treasury are helpful, there are several unanswered questions that remain. First, although it is not specifically stated, it would appear that because the grace period is an optional rule, the employer would have the ability to place a cap on the amount that can be carried over into the grace period. The new carryover guidance does not address whether the adoption of a grace period will effect discrimination testing requirements and irrevocable elections. The carryover guidance is also silent on whether the adoption of a grace period would cause flexible spending accounts to fall under the HIPAA portability rules and result in additional COBRA continuation coverage requirements. Arguably, this would not be an intended result of the Treasury guidance; however, additional clarification from the Treasury would be welcome in these areas.

This article is intended for general informational purposes only, and should not be construed as legal advice. Always contact your legal counsel for advice or answers to your questions.