Effect of Health FSA Carryovers on HSAs

Published date01 November 2015
Date01 November 2015
© 2015 Wiley Periodicals, Inc.
Published online in Wiley Online Library (wileyonlinelibrary.com).
DOI 10.1002/jcaf.22109
Effect of Health FSA Carryovers on HSAs
Shirley Dennis-Escoffier
With the open enrollment
period for most employee
health plans approaching, it
is important for employers to
provide their employees with
proper guidance on the tax
implications of their various
options. While most employ-
ees are familiar with flexible
spending accounts (FSAs),
employees may not understand
the impact that participation
in an FSA can have on their
ability to qualify for a health
savings account (HSA) in the
following year. If there is any
carryover of unused amounts
from a general‐purpose FSA
to the next year, that indi-
vidualmay be ineligible to
contribute to a HSA for the
entire next year.
In the past year, the Inter-
nal Revenue Service (IRS) has
provided guidance clarifying
the eligibility of taxpayers who
were participants in a health
FSA that had a carryover
provision and want to partici-
pate in an HSA in the follow-
ing year. As more employees
choose high‐deductible health
plans (HDHPs) in combination
with HSAs, employers need to
be aware of how best to handle
the transition. Employers
should pay particular attention
to the options they can adopt
to prevent employees from
automatically being ineligible
to participate in an HSA.
Health flexible spending
arrangements or flexible spend-
ing accounts are employer‐
established plans that reim-
burse employees for qualifying
medical expenses. They are
usually funded through sal-
ary reduction agreements in
compliance with the Internal
Revenue Code (IRC) Sec-
tion 125 cafeteria plan rules
under which employees receive
lower wages in exchange for
equivalent contributions to
their individual flexible spend-
ing account maintained by
the employer. These plans are
very popular because they
help employees budget for
large medical bills by allow-
ing participants to set funds
aside over time through payroll
Under the uniform cover-
age rule, the entire amount of
salary reduction contribution
elected for a plan year must be
available to reimburse medi-
cal expenses incurred any time
during that plan year, even if
the contribution has not yet
actually been deducted from
the employee’s pay. For exam-
ple, an employee could elect
to forgo $200 a month in 2015
from her paycheck resulting in
a $2,400 annual contribution
to the FSA. If that employee
incurred $2,400 of qualified
medical expenses in February
2015, the employee could use
the full $2,400 annual FSA
contribution for 2015 to pay
these medical expenses even
though that employee has
contributed only $400 into
theaccount at that point in
Paying medical expenses
out of an FSA allows the
employee to pay for these
expenses with dollars that have
not been subject to tax because
amounts paid into the FSA are
not included in the employee’s
gross income so they are not
subject to income, Social
Security, or Medicare taxes.
This results in tax saving for
both employees and employers.
The employer’s tax savings fre-
quently more than offsets the
costs of administering the plan.
The negative aspect of cafe-
teria plans is what is commonly
referred to as the use‐it‐or‐lose‐
it rule because it requires the
forfeiture of unused contribu-
tions remaining at the end of

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