Flexible spending accounts (FSAs) are a popular benefit that provide tax savings for both employees and employers. But when employees don’t use all their funds, balances may be forfeited under the “use‑it‑or‑lose‑it” rule. Here’s what employers need to know about handling these funds.
The Basics of FSAs
Employees can contribute pretax dollars to two types of FSAs:
- Health Care FSA – Covers eligible medical, dental, and vision expenses for employees and their dependents. The maximum contribution rises to $3,400 in 2026 (up from $3,300 in 2025).
- Dependent Care FSA – Covers qualifying child care or adult dependent care expenses. The contribution limit increases to $7,500 per household in 2026, compared to $5,000 in 2025.
Contributions reduce federal income tax, Social Security tax, and Medicare tax, while reimbursements remain tax‑free.
The Use‑It‑Or‑Lose‑It Rule
Unused balances typically revert to the employer, but there are exceptions:
- Grace Period – Up to 2½ months after year‑end (for calendar‑year plans, until March 15).
- Carryover (Health Care FSAs only) – Employees may carry over a limited amount. For 2026, the carryover limit rises to $680.
Note: Health care FSAs can offer either a carryover or a grace period, not both. Dependent care FSAs may only offer a grace period.
Employer Options for Forfeited Funds
Once grace periods or carryovers are applied, employers may use forfeited balances under IRS rules. Common options include:
- Offsetting administrative costs of the plan.
- Reducing employee contributions in future years (e.g., forfeited funds help employees reach a target balance).
- Returning funds to participants as taxable wages, subject to payroll and income tax withholding.
Employers must apply these options uniformly and nondiscriminatorily. Funds cannot be returned based on individual claims experience.
A Natural Check‑In Point
The grace‑period deadline is an ideal time for employers to review FSA plan design. Consider whether your plan’s grace period or carryover provisions align with employee needs and administrative practices. Proper handling of forfeitures ensures compliance and smooth enrollment for the next year.