IRS Guidance on How Health FSA Carryover Affects Eligibility for HSA Contributions

The IRS released a memorandum on March 28, 2014 that confirms that employees who have carryover from a prior year in a general purpose health FSA cannot contribute to an HSA in the following year.  However, employees may contribute to an HSA if the FSA funds are moved to an HSA-compatible health FSA or if they waive carryover.

 

CARRYOVER PROVISION CREATED QUESTIONS

 

When Notice 2013-71 was issued last October (see our article) announcing the new optional carryover provision for unused health FSA funds, questions were raised about how that might impact someone who wants to move to an HDHP with an HSA in the next Plan Year. Will health FSA coverage resulting from carryover make him ineligible to contribute to an HSA?  If so, how long? Will there be options available to prevent carryover from tainting HSA eligibility?

 

BACKGROUND

 

First, a brief summary of HSA eligibility and how it is impacted by FSA coverage:

  • In order to make contributions to a Health Savings Account (HSA) under Code Section 223 individual must be an “eligible individual”.
    • In order to be an  “eligible individual” you must be  covered by a qualified High Deductible Health Plan (HDHP) and cannot have any other health coverage that is not a HDHP, unless it is for “permitted coverage” such as one that pays only for dental, vision or preventative care.
      • A health FSA that reimburses all qualified section 213(d) medical expenses (aka: a general-purpose health FSA) is a health plan that constitutes other coverage that is not an HDHP.  A health FSA that reimburses only dental, vision or preventative care expenses, or expenses incurred after the statutory deductible has been met (aka: the limited-purpose health FSA)  is permitted coverage.
        • Consequently, an individual who is covered by a general -purpose health FSA is not an “eligible individual”, but the limited-purpose health FSA is OK to have along with an HSA.

ANSWERS

 

In a Chief Council Advice* memorandum released on March 28, 2014, Harry Beker, chief of the Health & Welfare Branch of the IRS provided advice in the form of seven examples and responses. The upshot of the guidance is summarized in the following Q&As:

 

Questions 1 & 2:

(1) May an otherwise eligible individual under section 223(c)(1)(A) of the Internal Revenue Code (the Code) contribute to an HSA if the individual participates in a general-purpose health FSA solely as the result of a carryover of unused amounts from the prior year? May he contribute to an HSA for any month after all of the carried over health FSA amounts are paid or reimbursed for medical expenses?

 

The Advice says:  No. He is ineligible for HSA contributions for the entire year following the year from which the unused funds were carried over – even the months after all funds are exhausted.

 

 Question 3 & 4:

 

May an individual who participates in a general-purpose health FSA and elects, for the following year, to participate in an HSA-compatible health FSA (that is, a limited-purpose health FSA) also elect to have any unused amounts from the general purpose health FSA carried over to the limited-purpose health FSA? Is this individual also eligible to contribute to an HSA during the following year if the individual is otherwise eligible under section 223(c)(1)(A) of the Code?

 

 The Advice says:  Yes. If he elects to have carryover apply to the limited health FSA for the following year, he is eligible to contribute to the HSA effective January 1, even though he has general-purpose FSA funds still available during the claim run-out period since those funds will only be available for claims incurred in the prior year during this time. Once the claim run-out period expires, unused funds may be carried over to the limited-purpose health FSA.

 

Question 5:

May a cafeteria plan that offers both a general purpose health FSA and an HSA compatible health FSA automatically treat an individual who elects coverage in a high deductible health plan (HDHP) for the following year as enrolled in the HSA compatible health FSA and carry over any unused amounts from a general purpose health FSA to the HSA-compatible health FSA for the following year?

 

 The Advice says:  Yes. But employers may want to exercise caution here and not assume that just because their employee is in the HDHP, they are also HSA-eligible. Other coverage or coverage under a spouse’s plan may make them ineligible for an HSA, and they may prefer to carry over unused amounts to a general-purpose health FSA.

 

Question 6:

If a cafeteria plan provides that an individual who participates in a general-purpose health FSA that provides for a carryover may decline the carryover for the following year, may the individual who so declines contribute to an HSA during the following year if the individual is otherwise eligible under section 223(c)(1)(A)?

 

                     The Advice says:  Yes, if the participant declines or waives their carryover amount prior to the beginning of the following year, they may contribute to an HSA during the following year if they are otherwise eligible under section 223(c)(1)(A).

 

ADMINISTRATIVE CONSIDERATIONS

 

It appears that participants who want to waive their carryover amount or apply it to a limited-purpose health FSA will need to make that election prior to the beginning of the next Plan Year in order to be HSA-eligible.  So having this guidance well in advance of next year’s open enrollment is welcome, as it will give employers and TPAs a roadmap for how to manage carryover as they approach the end of the Plan Year.

 

Employers who do not already offer an HSA-eligible Health FSA (e.g. the Limited Health FSA that pays only dental & vision care expenses) might want to consider adding that option at the beginning of the next plan year in order to create an option for employees who want to be HSA eligible and have carryover.

 

NEO will be providing further direction to clients who have FSA carryover and also offer HSA-compatible plans prior to their next open enrollment. In the meantime, it you have questions, or want to discuss adding the Limited Health FSA to your plan, contact us at BASIC NEO at admin@FlexNEO.com.

 

One last comment … the IRS memorandum in the form of  “Chief Council Advice”*  is not “official” guidance. Still, this informal guidance from the IRS to the IRS clearly has weight and is better than no guidance at all.

Chief Counsel Advice includes written advice or instructions prepared by the Office of Chief Counsel and issued to IRS field or service center employees. The advice conveys certain legal interpretations or positions of the IRS or Chief Counsel concerning existing or former revenue provisions.

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