Employers around the country are waking up to a serious and unexpected problem with their health care flexible spending accounts. The health reform law enacted several years ago quietly limited these popular “FSA” benefits to $2,500 per year, effective January 1, 2013. But the express terms of the law conflict with the explanation provided by Congress, and many employers are scratching their heads trying to figure out when plans must be changed to meet the requirements of the new law, and what amendment language must say.
Here’s the problem: The law says that FSAs are not “qualified” under tax law unless the plan provides that an employee’s salary deferral to fund the FSA does not exceed $2,500 “for any taxable year” beginning after December 31, 2012. “Qualified” status is important because if an FSA is not qualified, benefits payable under the plan become taxable income.
The $2,500 limit seems simple enough, and for FSAs that operate on a calendar year basis, it is. The taxable year for virtually all employees is the calendar year, and if an employer sponsors an FSA that runs from January 1, 2013 to December 31, 2013, employee salary deferrals must be limited to $2,500 during that period. In addition, plan amendments imposing the new limit will need to be in place by December 31, 2012 so that the plan remains qualified. But what about a plan that runs on a fiscal year that encompasses the effective date of the new law, say July 1, 2012 to June 30, 2013?
In this case, can the employee take advantage of unlimited salary deferrals until December 31, 2012, but then make sure the total of his or her deferrals in 2013 does not exceed $2,500? That would require the employer to keep track of an employee’s 2013 deferrals for six months in the plan year ending June 30, 2013, and for the first six months of the next plan year beginning July 1, 2013. A deferral election for the plan year beginning July 1, 2012 could affect how much a participant can defer in the following plan year beginning July 1, 2013. In some cases, the new limit also would require a change in the employee’s deferral elections after December 31, 2012, so that the 2013 $2,500 limit is met. And, what does the plan amendment need to say?
The other question at hand is whether the plan sponsor only has to worry about an election to defer made after December 31, 2012, making sure that the election is limited to $2,500 for the plan year beginning in 2013? Congress apparently thought so, because in the committee report that accompanied the health reform law, the committee stated that the salary deferral was “limited to $2,500 for a plan year” (emphasis added). If this is the case, employers need only worry about elections made for plan years beginning after December 31, 2012. For the July 1 plan mentioned above, that would be effective July 1, 2013. Further, the amendment would not have to be made until June 30, 2013.
In September, 2011, the IRS stated that it intended to issue guidance on the effective date of the $2,500 limitation. It hasn’t gotten around to that yet, and for employers who started FSA fiscal years in 2012 that will extend into 2013 (five months in 2012 have already passed), there are no sure answers. So, what action should these employers take, and what should employers do if their FSA arrangements use fiscal years that start sometime during the remainder of 2012?
Under these circumstances, taking no action is not an option. Moreover, until the IRS issues guidance clearing up the questions, we believe the best course is to take a conservative approach. In other words, because the statute is couched in terms of “tax” years rather than “plan” years, employers are best advised to follow the language of the law rather than the comments of the legislative committee. That means that for fiscal year plans that have already conducted 2012-13 elections, a plan amendment should be in place prior to January 1, 2012, imposing the $2,500 limit on deferrals during the tax year beginning January 1, 2013 and ending December 31, 2013, and for calendar years thereafter. This limit should be in place regardless of whether the plan uses a fiscal year rather than a calendar year. This also means that the employer will need to notify participants of this limitation and put in place accounting measures to ensure that limitations are not exceeded.
In some cases, employees have made elections in 2012 to defer more in 2013 than will be allowed. In such cases, we believe deductions in 2013 must be limited, regardless of the employee’s election. We expect the IRS to issue later in the year guidance discussing how this may be done, but employers must take it upon themselves to comply with the law even if guidance is not forthcoming. It remains to be seen whether the IRS will allow participants to accelerate 2012 deferrals to make sure that the total they elect to defer over the entire fiscal year is actually contributed. Generally, under applicable IRS regulations, an employer can specify any interval for salary deferrals, as long as those intervals apply uniformly to all participants and are not tied to benefit payments under the plan. If this is the case, periodic deferral amounts could be increased in 2012 and then be backed off in 2013 to comply with the $2,500 limit. Whatever the result, employers must be ready to act whether the IRS steps up with advice or not.
Bob Christenson, a partner in the Atlanta office of Fisher & Phillips LLP, may be reached at (404) 240-4256 or firstname.lastname@example.org.
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