IRS clarifies rules for rolling FSAs into HSAs

The IRS recently issued guidance for how employers can roll over their health Flexible Spending Arrangements and Health Reimbursement Arrangements to Health Savings Accounts for their employees.

Employees with FSAs or HRAs as of Sept. 21, 2006, are allowed a one-time roll over to an HSA by 2012. The guidance clarifies the requirements for making a roll over, which must be made directly to the custodian or trustee of the HSA.

Under the guidance, a health FSA with a grace period or HRA must be amended and a rollover selected by an employee before year end. The balance amount must be transferred to the HSA by March 15 of the following year. The ability to make these transfers will facilitate the transition to an HSA-eligible health plan when employees are covered by an HRA or FSA, the IRS said.

The IRS established rules on the grace period last year. The FSA grace period provides up to two and a half months after the end of the plan year during which FSA plan participants can incur expenses and be reimbursed from account balances unused at the end of the prior plan year.

The IRS noted that the recent changes do not affect the requirement that unused amounts remaining at the end of a health FSA’s plan year must be forfeited in the absence of a grace period.

In addition, the guidance provides a special transition rule for transfers for 2006. Under the transition rule, the amendment, election and transfer must have taken place by March 15, 2007.

In general, eligible individuals are those who, as of the first day of the month, are covered by a high deductible health plan and by no other health plan that is not an HDHP, with exceptions for certain disregarded coverage, including permitted insurance. An individual covered by a general purpose health FSA or general purpose HRA is not eligible to contribute to an HSA.

If an individual fails to remain HSA-eligible for one year following the distribution, the amount of the rollover is included in gross income and is subject to an additional 10 percent tax. v

Reprinted with permission of Small Business Tax News, Copyright 2007, 1-301-951-1240. This information is distributed with the understanding that the editor and publisher are not engaged in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional person should be sought.