TAX BULLETIN

Notice 2005-42 provides for a "grace period" in which participants can use up amounts remaining in their FSA's. Instead of having to spend the remaining amounts in the last month of the year, FSA plans can now provide participants with a "grace period" of up to two and one-half months after the end of the FSA plan year to incur expenses and pay for them, using money from the prior year. Therefore, FSA participants may have as long as 14 months and 15 days to incur expenses for the plan before forfeiting any remaining amounts.

Notice 2005-42 does not eliminate the use it or lose it rule. A cafeteria plan may not permit unused amounts to be cashed-out or converted to any other taxable or nontaxable benefit. Also, unused amounts in one FSA cannot be transferred to another FSA.

Cafeteria plan sponsors are not required to provide a grace period. However, if a sponsor wants to provide one, then the grace period must apply to all participants in the cafeteria plan. The cafeteria plan sponsor must amend the plan document before the end of the plan year for which it wants to implement the grace period. The cafeteria plan sponsor will also need to consider modifying the plan's "run-out" period. The ''run-out" period is the time period after the end of the plan year during which covered expenses must be submitted