The company can only use health FSA forfeitures for certain purposes. Under proposed IRS regulations, which may be relied upon pending the issuance of final regulations, these forfeitures may be:
- retained by the company;
- used to reduce required salary reduction amounts for the immediately following plan year, on a reasonable and uniform basis;
- returned to employees on a reasonable and uniform basis;
- used to increase the annual coverage amount; or
- used to defray administrative expenses.
Under the proposal, the forfeitures can never be allocated among employees based on their individual claims experience.
Although the proposed regulations provide certain alternatives for using health FSA forfeitures, not all of these options are available to health FSAs that are subject to ERISA. While most health FSAs are subject to ERISA because they provide welfare benefits to participants and beneficiaries, certain health FSAs, such as those sponsored by government plans and church plans, are exempt from ERISA generally (but may be subject to other non-ERISA requirements regarding the use of plan assets).
Exclusive benefit rule. Assuming that your health FSA is subject to ERISA, the use of participant forfeitures is subject to ERISA's fiduciary duty rules, including its exclusive benefit rule. That rule provides that plan assets cannot inure to the benefit of the employer and must be used for the exclusive purpose of providing benefits to plan participants and beneficiaries and defraying reasonable plan administration expenses. Therefore, despite the proposed IRS regulations, your company may not retain the participant forfeitures because doing so would violate ERISA's exclusive benefit rule. Similarly, using the health FSA forfeitures to pay for expenses associated with any other plan that your company sponsors — such as a dependent care plan, even if the plan covers the same participants as the health FSA — also would violate the exclusive benefit rule.
To determine which alternatives are available to your company, first confirm whether your company's health FSA is subject to ERISA because, if so, the options regarding the use of health FSA forfeitures are more limited. You also should review your health FSA plan document because it may specify how forfeitures must be applied, and any action you take with respect to these forfeitures must be in accordance with the terms of the plan document. Be careful to document the actions taken with respect to these forfeitures. For example, if the forfeitures are used to defray reasonable administration expenses, keep detailed records showing that the expenses paid relate directly to the FSA, the nature and amount of the expenses, and the dates on which the expenses were incurred and paid. Before using forfeitures, you should consult with experienced employee benefits counsel.