A Kinder, Gentler IRS? FSA rules get a little more flexible

Last modified: Tuesday, December 31, 2013

Putting money in a flexible spending account via payroll deductions can be a smart move, since the money - which must be spent on health-related expenses - isn’t subject to federal income tax. Given that individuals can set aside up to $2,500 in a health FSA, the tax savings can be significant.But there’s been one big downside to FSAs: their use-it-or-lose-it feature. If you put $800, say, in the account, and then don’t use it all up within the calendar year (or the relatively brief grace period that follows) you forfeit the unused funds.Figuring out how much to set aside in an FSA essentially calls for a crystal ball, as my husband can attest. A few weeks ago he was busy calculating (i.e., making educated guesses) how much he’ll spend on co-pays, prescriptions, contact lenses, etc., in 2014. His goal: a figure that takes full advantage of the FSA tax break - but doesn’t leave money on the table at the end of the year. It isn’t easy.At one time the IRS allowed individuals to spend whatever was left in their FSAs at year’s end by stocking up on medical staples like bandages and aspirin. Then, a few years ago, the agency got a lot pickier about what expenses qualify (bandages and aspirin are among the items that are now off the list).But last week the IRS displayed its softer side, announcing a change to the use-it-or-lose-it rule. Starting in 2014, individuals who underspend will be allowed to carry over FSA funds into the following year. An example: Say you anticipated spending $800 on doctor co-pays and prescriptions in 2014, so put that amount in your FSA. At year's end, though, it turned out you only spent $400. Under the new rule, you could use the remaining $400 in 2015 (on top of any additional amount you designate for your 2015 FSA account). The maximum carryover allowed is $500.Employers can choose whether or not to adopt the carryover feature, or instead stick with the existing grace period of two months and 15 days. Employers can also choose not to offer either option.If you want to see the fine print, here’s a link to IRS Notice 2013-71. And for those who find government gobbledygook impenetrable, here’s a link to the IRS’ own cheat sheet.