To Be, or Not To Be (Compatible With an HSA When Enrolled in a Health FSA), That Is The Question

For some, it is a question as old as, well, a few months at least since the IRS sanctioned carryovers in health FSAs. On Friday March 28th, the IRS provided some answers. In the form of a Memo from the Office of the Chief Counsel dated February 24, 2014, the IRS provided some guidance on health flexible spending arrangement (health FSA) carryovers and eligibility for a health savings account (HSA). For those employers who have already struggled with the questions presented by having both a high-deductible health plan (HDHP) with an HSA and a health FSA with a carryover feature, the guidance is welcome.

compatibleHDHPs and HSAs go hand-in-hand. An employee is eligible to contribute to the HSA only if there is no other health plan that covers any benefit that is already covered by the HDHP. The difficulty often arises when an employee is enrolled in the HDHP and some other medical benefit, making the employee ineligible to contribute to the HSA. Having a HDHP without the benefit of an HSA can be an expensive venture.

Or perhaps the employee’s spouse enrolls in a health FSA through the spouse’s employer – the employee with the HDHP cannot contribute to an HSA. A health FSA that reimburses all qualified medical expenses is a health plan that constitutes other coverage, which makes the employee ineligible to contribute to the HSA. The employee is only eligible to contribute to the HSA if the health FSA is a limited purpose health FSA or a post-deductible health FSA.

Things get even trickier if there is a health FSA with a carryover provision involved. Even if the employee (or spouse) does not make an election for the health FSA in Year 2, anticipating the need to make HSA contributions, if the health FSA has money leftover from Year 1 the employee may be ineligible to contribute to the HSA for all of Year 2.

The memorandum from the IRS provides some helpful guidance in dealing with these practical, and common, questions:

  1. May an otherwise eligible individual 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?  No.  Coverage in a general purpose FSA solely as a result of a carryover of unused amounts from the prior year is enough to make an otherwise eligible individual ineligible to contribute to an HSA for the entire FSA plan year.
  2. May an otherwise eligible individual who participates in a general purpose health FSA solely as the result of a carryover of unused amounts from the prior year contribute to an HSA for any month after all of the carried over health FSA amounts are paid or reimbursed for medical expenses? No.  Even after the carryover amount in the health FSA from Year 1 into Year 2 is spent down, the otherwise eligible individual cannot contribute to the HSA for the rest of the health FSA plan year.
  3. 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, a post-deductible health FSA, or combination of both) also elect to have any unused amounts from the general purpose health FSA carried over to the HSA-compatible health FSA? Yes, this is permissible.  Warning: The unused amounts cannot be carried over to a non-health FSA or another benefit in the cafeteria plan. 
  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 and have any unused amounts from the general purpose health FSA carried over to the HSA-compatible health FSA also contribute to an HSA during the following year? Yes. An otherwise eligible individual participating in a general-purpose health FSA in Year 1 can elect to have any unused amounts carry over into a limited purpose health FSA (or a post-deductible health FSA) in Year 2 and be eligible to contribute to an HSA in Year 2.
  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 HDHP as enrolled in the HSA-compatible health FSA and carry over any unused amounts from the general purpose health FSA? Yes. The employee who elects the HDHP health plan for the next year can automatically be treated as having also elected the limited purpose health FSA (or post-deductible health FSA) for the next  year and carry over leftover amounts up to $500 from the general purpose health FSA.
  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 decline the carryover and contribute to an HSA during the following year? Yes. The cafeteria plan may allow the individual to decline or waive the carryover prior to the beginning of the next plan year, and the otherwise eligible individual can contribute to an HSA in the next plan year.
  7. If an individual elects to carry over unused amounts from a general purpose health FSA to an HSA-compatible health FSA, how do the uniform coverage rules apply during the run-out period of the general purpose health FSA? This is the most complicated issue of them all. Ordering of the claims and reimbursements in this situation is important.
    • In Year 1, employee was enrolled in a general purpose health FSA with a $500 carryover provision.
    • In Year 2, employee elects a HDHP and $2500 in a limited purpose health FSA with a $500 carryover provision.
    • At the end of Year 1 (December 31), $600 remains in the general purpose health FSA.
    • In January of Year 2, employee incurs and submits to the limited purpose health FSA a $2700 claim. As per the uniform coverage rules, the plan reimburses $2500, the full amount elected.
    • In February of Year 2, employee submits a $300 claim incurred in December of Year 1. The claim is reimbursed from the general purpose health FSA because it is within the Year 1 run-out period.
    • At the end of the Year 1 run-out period, $300 remains in the general purpose health FSA. The $300 remaining is carried over into the limited purpose health FSA.
    •  After the $300 is carried over to the limited purpose health FSA, the employee is reimbursed $200 for what remained on the claim incurred and submitted in January of Year 2.
    • $100 remains in the limited purpose health FSA, which can be used for expenses incurred in Year 2 or carried over into Year 3.
    •  Employee can contribute to an HSA for all months in Year 2.

Question and Answer 7 is not an easy one to follow. It takes more than one reading. No doubt in time, like everything else the regulators have given us lately, this will seem second nature.

One final note of caution … the IRS memorandum is not “official” guidance. It even says in the second line, “[t]his advice may not be used or cited as precedent.” Still, when given the choice, informal guidance is better than no guidance.

If you would like to refresh your knowledge of the new carryover feature that is allowed for health FSA plans, refer to IRS Notice 2013-71. The rules for when an individual is eligible to make HSA contributions can be found in Section 223(c)(1)(A) of the Code with additional information provided by IRS Notice 2005-86. Still need help? The consultants at Hill, Chesson & Woody are here to help, contact HCW at info@hcwbenefits.com.

Sign up to receive breaking news on Healthcare Reform by the HCW Compliance Team