Many employers offer health care and dependent care flexible spending accounts (FSAs) as part of their employee benefits package. These plans can deliver meaningful tax savings for employees and payroll tax savings for employers.
If your company’s FSA operates a calendar-year basis and includes a 2½-month grace period, employees have until March 15, 2026 to incur eligible expenses using their 2025 plan balances.
After that date, any remaining 2025 funds may be forfeited under the “use-it-or-lose-it” rule. Below is a quick refresher on how FSAs work and the options employers have for handling forfeited amounts.
The basics
Under an employer-sponsored FSA plan, employees may be able to contribute a portion of their pay to a:
Health care FSA. These accounts may be used for qualifying out-of-pocket medical, dental and vision expenses for the employee and his or her spouse and/or qualified dependents. For 2026, the maximum employee contribution to a health care FSA increases to $3,400 (from $3,300 in 2025). (The limit is annually indexed for inflation.)
Dependent care FSA. These accounts may be used for qualifying child care or adult dependent care expenses. For 2026, under 2025 tax legislation, the dependent care FSA contribution limit increases to $7,500 per household ($3,750 for married couples filing separately). The limit for 2025 was $5,000 ($2,500 for separate filers). (The limit isn’t inflation-indexed, so it will not go up in the future unless another increase is passed by Congress and signed into law.)
Employee contributions are made on a pretax basis, reducing federal income tax, Social Security tax and Medicare tax (and often state income tax). The FSA plan directly pays or reimburses employees for qualified expenses, and the payments or reimbursements are tax-free.
Use-it-or-lose-it rule
If employees do not use their full FSA balances by the end of the plan year, leftover balances generally revert to the employer under the use-it-or-lose-it rule. However, there are two exceptions:
- An FSA plan can allow a grace period of up to 2½ months. Most FSA plans operate on a calendar-year basis. For a calendar-year FSA plan, the grace period gives employees until March 15 of the following year to incur qualified expenses to drain their unused FSA balances from the previous year.
- A health care FSA plan can allow employees to carry over up to an annually inflation-indexed amount of unused balances from one year to the next. The amount that can be carried over from 2026 to 2027 is $680 (up from the $660 that could be carried over from 2025 to 2026).
It is important to note that a health care FSA plan can offer either the carryover or the grace period, but not both. Dependent care FSA plans can offer only the grace period, not the carryover.
Options for forfeited FSA funds
After any applicable grace period ends, or after applying any permitted health care FSA carryover, employers may retain forfeited balances under IRS cafeteria plan rules. Many businesses use the funds to offset plan administrative expenses.
Other permitted uses generally include, on a reasonable and uniform basis: 1) reducing the amount employees need to contribute in a future year to reach a certain FSA balance (for example, employees need to contribute only $950 to have a $1,000 FSA balance, with the extra $50 funded by forfeited balances from a previous year), or 2) returning amounts to participants (typically treated as taxable wages and subject to payroll taxes and income tax withholding).
Forfeitures ca not be returned to plan participants based on individual claims experience. Any allocation of returned funds must be nondiscriminatory and consistent with plan terms.
Natural check-in point
As the grace-period deadline approaches, it is a good time for employers to take a fresh look at how their FSA plan handles unused balances. This review can also help confirm that your current plan design, including grace period or carryover provisions, still fits your employees’ needs and matches your administrative practices. Contact us at Rudler to help review and modify your FSA plan provisions, ensure forfeitures are handled properly and get ready for next year’s enrollment cycle.
RUDLER, PSC CPAs and Business Advisors
This week's Rudler Review is presented by Kacie Hamlett, Senior Accountant and Matt Topmiller, CPA.
If you would like to discuss your particular situation, contact Kacie or Matt at 859-331-1717.
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