To amend the Internal Revenue Code of 1986 to allow amounts elected for reimbursement of medical care expenses under a health flexible spending arrangements, as defined in Code Section 106(c)(2) and the regulations promulgated under Section 125, that are unused during a Plan Year to be carried over within the account to subsequent plan years for the reimbursement of future eligible medical expenses.

SECTION 1. CARRYOVER OF UNUSED BENEFITS FROM HEALTH FLEXIBLE SPENDING 
              ARRANGEMENTS.

    (a) In General.--Section 125 of the Internal Revenue Code of 1986 
(relating to cafeteria plans) is amended by redesignating subsections 
(h) and (i) as subsections (i) and (j), respectively, and by inserting 
after subsection (g) the following new subsection:
    ``(h) Allowance of Carryovers of Unused Funds to Subsequent Taxable 
Years.--
            ``(1) In general.--For purposes of this title--
                    ``(A) a plan or other arrangement shall not fail to 
                be treated as a cafeteria plan or health flexible 
                spending arrangement, and
                    ``(B) no amount shall be required to be included in 
                gross income by reason of this section or any other 
                provision of this chapter,
        solely because under such plan or other arrangement any amounts 
        elected for reimbursement of eligible medical care expenses 
        under a health flexible spending arrangement which are unused 
        during a plan year may be carried forward to one or more 
        succeeding plan years.
            ``(2) Amounts included in gross income.--Any carryover 
        amount described in subsection (h)(1) shall be included in 
        gross income for purposes of Federal withholding and employment 
        tax purposes, including FICA taxes. Any amount carried over 
        under this subparagraph shall be treated as wages for the 
        taxable year in which the amounts were determined to be carry 
        over amounts as described in subsection (h)(1).
            ``(3) Treatment of and limitation on rollover amounts.--
        Amounts carried over under subparagraph (h)(1) shall be limited 
        as follows:
                    ``(A) Amounts carried forward pursuant to 
                subsection (h)(1) shall be limited to $2,000 per plan 
                year (as indexed for future years by the cost of living 
                adjustment determined under section 1(f)(3)). Any 
                unused amounts during any plan year in excess of this 
                amount shall be forfeited and shall be treated in 
                accordance with the applicable regulations issued under 
                section 125.
                    ``(B) Amounts carried forward pursuant to 
                subsection (h)(1) shall be used only for reimbursement 
                of Qualified Medical Care Expenses defined in 
                subsection (h)(5) below.
                    ``(C) The employer may invest such carryover 
                amounts in guaranteed principle and interest 
                investments which provide 100 percent liquidity within 
                the account.
            ``(4) Forfeitures for terminating participants permitted.--
        Nothing in this subsection shall preclude the application of 
        the requirement set forth in the regulations promulgated under 
        section 125 that participants who terminate participation prior 
        to the end of the plan year must forfeit any health flexible 
        spending arrangement account balance provided such amounts do 
        not consist of carry over amounts described in subsection 
        (h)(1).
            ``(5) Qualified medical expenses.--
                    ``(A) In general.--The term `qualified medical 
                expenses' means, with respect to subsection (h)(3) 
                above, amounts paid for medical care (as defined in 
                section 213(d)) for such individual, the spouse of such 
                individual, and any dependent (as defined in section 
                152) of such individual, but only to the extent such 
                amounts are not compensated for by insurance or 
                otherwise.
                    ``(B) Health insurance expenses.--
                            ``(i) In general.--Subparagraph (A) shall 
                        not apply to any payment for coverage under a 
                        group health plan of an employer of the health 
                        flexible spending arrangement participant or 
                        the spouse of the participant.
                            ``(ii) Exceptions.--Clause (A) shall not 
                        apply to any expense for coverage under--
                                    ``(I) a group health plan during 
                                any period of continuation coverage 
                                required under any Federal law,
                                    ``(II) a qualified long-term care 
                                insurance contract (as defined in 
                                section 7702B(b)),
                                    ``(III) a Medicare supplemental 
                                policy under section 1882 of the Social 
                                Security Act, or
                                    ``(IV) an individual health 
                                insurance policy.
            ``(6) Carryover amounts to be expended after health 
        flexible spending arrangement contribution.--All Qualified 
        Medical Care Expenses defined in subsection (h)(5)(A) that are 
        submitted for reimbursement must be reimbursed first from 
        amounts in the participant's health care flexible spending 
        arrangement that do not constitute carryover amounts described 
        in subsection (h)(1), to the extent such amounts may be 
        reimbursed from the portion of the health flexible spending 
        arrangement that does not consist of carryover amounts pursuant 
        to rules set forth in the regulations promulgated under section 
        125 relative to health flexible spending arrangements.
            ``(7) Treatment of carryover amounts following termination 
        of employment or other loss of eligibility.--Upon a termination 
        of employment or other loss of eligibility under the health 
        care flexible spending arrangement, the Employer must provide 
        for one or more of the following methods of distribution of a 
        Participant's accumulated carryover amount plus interest earned 
        and allocated to such Participant pursuant to subsection 
        (h)(3)(C):
                    ``(A) The Participant's accumulated carryover 
                amount, including any interest earned and allocated to 
                such health care spending arrangement balance pursuant 
                to (h)(3)(C), may be retained by the Employer to be 
                used to reimburse Qualifying Medical Care Expenses of 
                the former participant and the former employee's spouse 
                or dependents incurred after the date of termination;
                    ``(B) The carryover amount calculated as of the day 
                of the termination of employment or other loss of 
                eligibility may be transferred to the subsequent 
                employer to be used by the former participant in a 
                manner consistent with the rule of this subsection (h), 
                provided the subsequent employer provides a similar 
                arrangement and agrees in writing; or
                    ``(C) The employer may distribute the carryover 
                amount, including any interest earned and allocated to 
                such account pursuant to subsection (h)(3)(C), to any 
                appropriate vehicle as defined by the Department of 
                Treasury in regulations or to the participant in cash. 
                If carryover amounts are received in cash, the interest 
                earned and allocated to such participant pursuant to 
                subsection (h)(3)(C) shall be treated as ordinary 
                income for purposes of Federal tax purposes.
        The employer must offer at least one of the options set forth 
        above; however, nothing in this subsection requires the 
        employer to offer more than one option. If the employer offers 
        more than one of the options listed above, the employee must 
        choose the applicable option within 60 days of the date of 
        termination of employment or loss of eligibility. Should no 
        election be made, the funds will revert to the employer 
        consistent with Federal regulations. If the termination of 
        employment or loss of eligibility is a result of the 
        participant's death, the surviving spouse, or dependents, if no 
        surviving spouse, will receive the participant's carry over 
        funds in a manner consistent with (h)(7)(C).''.
    (b) Effective Date.--The amendments made by this section shall 
apply to taxable years beginning after December 31, 2001.

Summary: Amends the Internal Revenue Code to allow the limited carryover of unused benefits from health flexible spending arrangements to subsequent taxable years to be used for the reimbursement of future medical expenses.