Employers who offer health care flexible spending accounts under their cafeteria plans were given a “treat” on October 31, 2013, when the Internal Revenue Service released Notice 2013-71 permitting employers to implement a $500 carryover. However this “treat” may be “tricky” to implement.

The Notice permits employers to amend their cafeteria plans to add an exception to the use-it-or-lose-it rule for health care flexible spending accounts (FSAs). The use-it-or-lose-it rule prohibits any money remaining in an employee’s FSA from reverting to the employee or being used for medical expenses incurred after the end of the plan year in which it was contributed. One exception to this rule permits a cafeteria plan to provide a grace period that allows employees to use amounts left in FSAs to pay for medical expenses incurred during the first two and one-half months of the plan year following the year in which they were contributed.

Under Notice 2013-71, a cafeteria plan may be amended to permit up to $500 remaining in each employee’s FSA at the end of the plan year to be carried over into the following year, as long as the plan does not also use a grace period. The carryover provision is optional for cafeteria plans and may be implemented for the 2013 plan year, the 2014 plan year or any future plan year.

Employees will likely view an FSA carryover feature favorably as it takes some of the pressure off when deciding how much to elect to contribute to an FSA on an annual basis. However, as employers evaluate whether to implement a carryover feature and if so, when, there are factors that should be considered before making a plan amendment.

First, is the FSA administrator able to administer the requirements of Notice 2013-71? The Notice sets forth how expenses submitted for reimbursement are to be paid and how reimbursements affect both the FSA values for the prior year and the current year. An FSA administrator’s system may not be able to handle the additional requirements of Notice 2013-71. Prior to deciding whether to implement the carryover feature, an employer should confirm that its third-party administrator can administer the plan in time for the effective date of the amendment.

In addition, if the employer also sponsors a high-deductible health plan with a health savings account, consideration should be given to how the FSA carryover will affect an employee’s eligibility to make deductible contributions to a health savings account. Under Notice 2005-86, an employee cannot make deductible contributions to a health savings account during any month the employee is eligible to have medical expenses reimbursed from an FSA from a prior year during a grace period. While not covered by Notice 2013-71, there is a risk that future IRS guidance will provide a similar limitation on employees who have amounts carried over from a prior year. An employee who decides to begin participating in a high-deductible health plan with a health savings account contribution may not be eligible for the health savings account contribution during the entire first year he or she participates in the health plan if the employee has an FSA account with money carried over from the prior year.

While the IRS likely intended the FSA carryover feature to provide a benefit to employers and employees alike, there are many pitfalls to avoid in its implementation.