New IRS Rule Affords Greater Flexibility for Medical Reimbursement Plans

Summer 2005Cole Schotz DocketAttorney: Gary A. Phillips

On June 6, 2005, the Internal Revenue Service issued Notice 2005-42, which will now permit for participants of flexible spending account plans a grace period immediately following the end of each plan year during which unused contributions remaining at the end of the plan year may be paid to plan participants for qualified benefit expenses incurred during the grace period.  Flexible spending benefit plans allow plan participants to pay for their unreimbursed medical expenses with pre-tax dollars.  A plan participant makes an election prior to the beginning of each calendar year to have a portion of his or her salary reduced and set aside in a separate account to pay for the participant’s unreimbursed medical expenses.  Before the change, the plan participant had to use all of his or her flexible spending benefit plan account dollars by year’s end or forfeit the balance to the employer.  This was known as the “use it or lose it rule”.  Employers now can give participants an additional 2 ½ month post year-end grace period during which unused contributions may be used.  As a result, a participant now has 14 months and 15 days to use the contributions for a plan year before they are forfeited under the “use it or lose it” rule.  This new rule should not be confused with the existing rule that enabled participants to submit receipts post year-end to be reimbursed for medical expenses incurred only during the plan year.  To adopt this change for the 2005 plan year, employers should amend their plan documents prior to 2005. 


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