Employer Options for Forfeited Cafeteria Plan Funds 

Q.       What are employers allowed to do with forfeited, unused employee flexible spending account (FSA) dollars?

A.       The Internal Revenue Service (IRS) generally provides employers with a few options for forfeited balances, depending on which Flexible Spending Account (FSA) plan is available to the employees. Recently, though, it should be noted that the IRS has allowed for more flexibility in plans to assist with the nation’s response to the COVID-19 outbreak, which may reduce, or even eliminate, the number of employees with a forfeited balance. This additional relief has recognized that, because of the outbreak, unanticipated changes in the availability of certain medical care and dependent care may mean that employees are more likely to have unused amounts at the end of the plan years. With this consideration, the IRS has developed temporary exceptions to avoid forfeitures.

The Internal Revenue Code essentially provides for two general types of Section 125 cafeteria plans: healthcare assistance and dependent care assistance. Employers can adopt plans which allow for a grace period under both types of plans that will allow employees to spend unused account funds. For healthcare plans, an employer can adopt a plan which currently allows for carryover of up to $550 at the end of the year. Under the statutory and regulatory requirements, amounts that have not been spent by the end of the grace period, nor carried over to the next year’s plan (and do not fall into any of the temporary guidelines under the emergency COVID-19 rules), are forfeited under a “use-or-lose” rule.

Legally, an employer who maintains a cafeteria plan can either retain these forfeited funds (potentially subject to tax and ERISA limitations) or use in one of three ways: (i) defray expenses to administer the cafeteria plan, (ii) return to the employee on a reasonable and uniform basis, or (iii) reduce the required salary reduction amounts for the next plan year on a reasonable and uniform basis. Allocating on a reasonable and uniform basis for purposes of these options means that the employer must evenly distribute the amounts based on a permissible basis, i.e., different coverage levels but not based on actual contributions.

Typically, the option to defray administration costs is the most-commonly chosen option, because it is the most cost effective and requires the least amount of administration and direct communication with the employees. Whichever option is chosen, be sure to indicate the option chosen in your plan document and coordinate with your third-party administrator (TPA) to ensure that the option can be handled by your TPA.

Jason R. Mau is a shareholder in the Boise office of Parsons Behle & Latimer. He can be reached at 208-562-4898 or jmau@parsonsbehle.com.