IRS clarifies puzzling issue sparked by new FSA carryover rules

The IRS finally caved and let health flexible spending account (FSA) holders carry over some funds from year to year. But that allowance opened up a whole different can of worms.  
The question the IRS’s new FSA rules have created: Can carrying over FSA funds prevent an individual from participating in a health flexible spending (HSA) account?
Answer: Yes.
The only exception: If your cafeteria plan offers an HSA-compatible health FSA, which tend to cover dental, vision, and some preventive care and pharmaceutical expenses not covered under a health insurance plan.
This is according to informal guidance released via a memorandum from the IRS Office of Chief Counsel.
FSA carryover funds count as ‘other health coverage’
To qualify for an HSA, an individual must be covered under a high-deductible health plan (HDHP) and have no other health coverage, among other requirements.
And, according to the IRS, a health FSA that pays or reimburses medical expenses (including copays and deductibles) qualifies as other health coverage.
In other words, if you have a general purpose health FSA — not an HSA-compatible health FSA — you have “other health coverage” that disqualifies you from participating in an HSA for the entire plan year.
Even if all you have in the FSA is carryover funds from the year before, you’re still disqualified from participating in an HSA for the plan year.
The IRS’ advice to individuals wishing to participate in an HSA: Do not carryover any FSA funds into the next plan year — or make sure carryover funds are deposited in an HSA-compatible FSA.
Additional guidance for employers: If your cafeteria plan offers both a general-purpose health FSA and an HSA-compatible FSA, you may automatically place any FSA carryover funds of HDHP enrollees into the HSA-compatible FSA for the following year.
Of course, all of this assumes your plan has adopted the IRS’ new carryover option — and no longer allows account holders to take advantage of the traditional grace period. The IRS says plans can elect either the carryover or grace period — but not both.