February 2007 | Volume VI, Issue 2

On February 15, 2007, the IRS released Notice 2007-22.

This notice provides guidance on rollovers from Health Flexible Spending Arrangements (FSAs) and Health Reimbursement Arrangements (HRAs) to Health Savings Accounts (HSAs) under the amendments to the Internal Revenue Code by section 302 of the Health Opportunity Patient Empowerment Act of 2006 (HOPE) included in the Tax Relief and Health Care Act of 2006, enacted on December 20, 2006. This guidance also provides transitional relief for rollovers completed before March 15, 2007.

The permanent guidance on rollovers from FSAs and HRAs to HSAs is effective beginning December 20, 2006 through December 31, 2011.

Under HOPE the new rules provide, in limited circumstances, certain amounts in a health FSA or HRA to be rolled over into an HAS (qualified HSA distribution). Under the new rules all of the following conditions must be satisfied in order to receive favorable tax treatment on the rollover amount:

By plan year end -

  • The plan must be amended
  • The employee must elect the rollover
  • The year-end balance must be frozen

The funds must be transferred by the employer within two and a half months after the end of the plan year and result in a zero balance in the health FSA or HRA.

Under the transitional relief for amounts remaining at the end of the 2006 plan year, however,

  • There is no requirement to freeze the year-end balance in the health FSA or HRA and
  • The amendment, election, and transfer must be completed by March 15, 2007.

The permanent rule for individual with a zero balance in their general purpose health FSA on the last day of the plan year is – the individual does not fail to be an eligible individual as of the first day of the immediately following health FSA plan year because of coverage during a health FSA grace period.

Permant Rule For Plan-Year-End Rollovers From General Purpose FSA/HRA

Transitional Rule For Plan-Year-End Rollovers From General Purpose FSA/HRA

An employee with a balance in a general purpose health FSA with a grace period or general purpose HRA at the end of a health FSA or HRA plan year is treated as an eligible individual for HSA purposes as of the first day of the first month in the immediately following plan year that the individual has HDHP coverage on the first day of the month if:

An employee with a balance in a general purpose health FSA or general purpose HRA after December 31, 2006 is treated as an eligible individual for HSA purposes as of the first day of the first month in 2007 that the employee has HDHP coverage on the first day of the month if:

1. The employer amends the health FSA or HRA written plan effective by the last day of the plan year to allow a qualified HSA distribution,

1. The employer amends the health FSA or HRA written plan effective by the last day of the plan year to allow a qualified HSA distribution,

2. A qualified HSA distribution form the health FSA or HRA has not been previously made on behalf of the employee with respect to that particular health FSA or HRA,

2. A qualified HSA distribution form the health FSA or HRA has not been previously made on behalf of the employee with respect to that particular health FSA or HRA,

3. The employee has HDHP coverage as of the first day of the month during which the qualified HSA distribution occurs, and is otherwise an eligible individual,

3. The employee has HDHP coverage as of the first day of the month during which the qualified HSA distribution occurs, and is otherwise an eligible individual,

4. The employee elects by the last day of the plan year to have the employer make a qualified HSA distribution from the health FSA or HRA to the HSA of the employee,

4. The employee elects on or before March 15, 2007, to have the employer make a qualified HSA distribution from the health FSA or HRA to the HSA of the employee,

5. The health FSA or HRA makes no reimbursements to the employee after the last day of the plan year,

  

6. The employer makes the qualified HSA distribution directly to the HSA trustee by the fifteenth day of the third calendar month following the end of the immediately preceding plan year, but after the employee becomes HSA-eligible,

6. The employer makes the qualified HSA distribution directly to the HSA trustee by the fifteenth day of the third calendar month following the end of the immediately preceding plan year, but after the employee becomes HSA-eligible,

7. The qualified HSA distribution from the health FSA or HRA does not exceed the lesser of the balance of the health FSA or HRA on (a) September 21, 2006, or (b) the date of the distribution,

7. The qualified HSA distribution from the health FSA or HRA does not exceed the lesser of the balance of the health FSA or HRA on (a) September 21, 2006, or (b) the date of the distribution,

8. (a) After the qualified HSA distribution there is a zero balance in the health FSA or HRA and the employee is no longer a participant in any non-HSA compatible health plan or (b) effective on or before the date of the first qualified HSA distribution the general purpose health FSA or HRA written plan is converted to an HSA-compatible health FSA or HRA, as described in Rev. Ruling 2004-45, for all participants.

8. (a) After the qualified HSA distribution there is a zero balance in the health FSA or HRA and the employee is no longer a participant in any non-HSA compatible health plan or (b) effective on or before the date of the first qualified HSA distribution the general purpose health FSA or HRA written plan is converted to an HSA-compatible health FSA or HRA, as described in Rev. Ruling 2004-45, for all participants.

Before implementing the FSA rollovers, consider some of these more complicated administration issues that Notice 2007-22 has created:

  • The employer must amend the health FSA or HRA written plan document and SPD prior to allowing the rollovers.
  • Even if qualified HSA distribution reduces the balance of an FSA or HRA to zero, the health FSA or HRA coverage does not end. Therefore, if employee has a general purpose FSA and requests a mid-year rollover that zeros out the account balance, the employee is still not eligible for an HSA until the end of the plan year.
  • An employee who begins HDHP coverage after the first day of the month is not an eligible individual until the first day of the next month. Thus, if an employee begins HDHP coverage after the first day of the month, any qualified HSA distributions on behalf of the individual made before the first day of the next month is included in the employees income and subject to an additional 10 percent tax.
  • If an employee elects to rollover any health FSA balance at the end of the plan year to an HSA, then the employee cannot submit any additional claims after end of plan year, regardless of when the underlying expense was incurred, nor can any claims be paid after the end of the plan year, even if they were incurred and submitted before the rollover of funds from the FSA to HSA.

Example: Employer Y has a calendar year general purpose health FSA with a grace period ending on March 15, 2008. Employer Y offers the employees the option of electing a HDHP coverage for the plan year beginning January 1, 2008.

Before January 1, 2008, Employer Y amends the health FSA to allow for qualified HSA distributions. The amended plan allows an employee electing HDHP coverage to also elect to have any health FSA balance at year-end, determined on a cash basis, contributed directly to an HSA trustee for the employee. For this purpose, the year-end balance is the balance of the health FSA without regard to any expenses incurred but not paid. Under the amendment, if any employee elects the qualified HSA distribution, the employee cannot submit any additional claims after December 31, 2007, regardless of when the underlying expense was incurred, nor are any claims paid after December 31, 2007 even if submitted prior to December 31, 2007. The notice contains many examples of the permanent and transitional guidance and how to apply the rules.

For a complete copy of the notice click on the link below. http://www.irs.gov/pub/irs-drop/n-07-22.pdf

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