The California Legislature recently passed Assembly Bill 1554, adding to the required notices that employers must deliver to participants in Flexible Spending Account (FSA) plans, including health, dependent care, and adoption assistance plans. The new law, signed on August 31, 2019 and becoming effective on January 1, 2020, provides that all employers sponsoring FSA plans must provide notice to participants of deadlines to withdraw funds. Notice must be given to each participant twice prior to the plan year’s end and in different forms.

Action items

  • For health FSAs: As described below, there is a strong possibility that the new law requiring notices to participants in health FSA plans is preempted by federal law, rendering the new law inapplicable in that respect. However, employers may want to consider complying until the federal courts make a final ruling because the law is relatively easy to comply with and is helpful for employees.
  • For dependent care and adoption assistant FSAs: Dependent care and adoption assistance FSAs likely are subject to this new law because preemptive federal law does not apply to these plans generally. We recommend employers become familiar with the new law and implement administrative processes to deliver notices to participants in 2020.

BACKGROUND ON FSA DEADLINES

The use-it-or-lose-it rule

Most employers will already be familiar with the use-it-or-lose-it rule for FSA plans. Under the Proposed Treasury Regulations to Section 125 of the Internal Revenue Code, the funds available to participants in an FSA expire on an annual basis, the “use-it-or-lose-it rule.” This hard deadline is subject only to a run-out period during which claims incurred in the previous year may be reported. For calendar year plans, the run-out period lasts through March 15 of the next year. After this period, the participants’ FSA funds are forfeited.

Ways to navigate the use-it-or-lose-it rule

Carryover (for health FSAs only)

To address the forfeiture of funds, the IRS issued Notice 2013-71 that provides that health FSAs may permit up to $500 to be carried forward annually, without expiration. However, this guidance applies only to health FSAs. Accordingly, dependent care and adoption assistance FSAs require a separate approach to FSA forfeitures.1

Grace period (for any FSA)

Another typical method to address FSA forfeitures is to provide participants with a grace period. Unlike carryovers, which apply exclusively to health FSAs, all types of FSAs may have a grace period. The grace period lasts for the same amount of time as the run-out period. With a grace period, no amount of expiring funds is carried-over into the following plan year; instead, the entire amount of funds in the FSA from the previous year is available to pay claims incurred during the grace period. The run-out period is still available and applies at the end of the grace period. This means that the FSA participant may use the entire previous year balance for claims incurred up to March 15 following the plan year and still have an additional run-out period in which to pay any previously incurred claims.2

Permitting carryovers or grace periods

Carryovers and grace periods are both features which must be stated in the FSA plan document. If an FSA plan does not already contain one of the features, the sponsor may amend the plan document to add either.

As stated by the IRS, an amendment to the FSA to add a carryover feature “must be adopted on or before the last day of the plan year from which amounts may be carried over.” Such an amendment “may be effective retroactively to the first day of that plan year.”

Alternatively, the FSA plan may be amended to provide for a grace period by following the written plan requirements under the proposed regulations. If the plan is amended to permit a carryover in place of a grace period, however, the sponsor should wait until the following plan year due to the contractual nature of the grace period. Participants have an expectation that funds will be available to pay for claims arising during the grace period.

Generally, amending the plan will require sufficient notice to allow participants to understand how carryovers and grace periods work. This notice gives participants a chance to make claims against their accounts balances that can no longer be used or carried over, similar to the purpose served by the California notice requirements. Participants will also need to be given advance notice of the addition of a carryover feature because otherwise, it will be too late to provide an ERISA summary of material modifications. Finally, if the FSA is subject to ERISA such an amendment may constitute a material reduction in benefits, which will require giving notice to participants on an accelerated basis.

ERISA PREEMPTION

Federal law is controlling in the field of employee benefit plans under the Employee Retirement Income Security Act of 1974 (ERISA). Under Section 514 of ERISA, state law is superseded as it applies to any employee benefit plan, with only few exclusions.3 Accordingly, any company employee benefit plan is usually only subject to federal jurisdiction. Because FSAs providing health benefits are specifically included within the scope of ERISA Section 3(1) as employee welfare benefit plans, the California law is likely preempted with respect to health FSAs.

COMPLYING WITH CALIFORNIA’S NEW NOTICE REQUIREMENTS

Covered plan types

As mentioned above, the new law’s FSA notice requirements apply to any flexible spending account.

Methods of compliance

If an employer sponsors any of the above FSA plans, notice of deadlines to withdraw funds must be sent to participants twice and in two different forms. The new notice requirements, however, are quite permissive, and notice in one form may be electronic. The law expressly states that the notices may be made in, and are not limited to, any of the following forms:

  • Electronic mail communication
  • Telephone communication
  • Text message notification
  • Postal mail notification
  • In-person notification

Purpose of the double-notice requirement

The purpose of requiring notices is to encourage FSA participants to take full advantage of their tax-advantaged FSA accounts and use funds that would otherwise be forfeited. The double-notice requirement makes it more likely that participants will stay informed of the deadlines to use their FSA funds before expiration.