Guidance clarifies FSA changes

Earlier this year, the Internal Revenue Service issued Notice 2012-40, which provides guidance on the changes made to health flexible spending arrangements under the Patient Protection and Affordable Care Act. Effective January 1, 2013, PPACA limits health FSA salary reduction contributions to $2,500. The $2,500 limit will be indexed for cost-of-living adjustments for plan years beginning after December 31, 2013. Historically, there has been no limit on the amount of salary reduction contributions that employees may elect under health FSA plans, subject to employer-imposed plan limits.

Notably, Notice 2012-40 clarifies that the limit does not apply for plan years beginning before Jan. 1, 2013. Thus, a health FSA plan run on a noncalendar-year basis will not be required to comply with the $2,500 limit until the first plan year beginning on or after January 1, 2013. In addition, for health FSA plans providing a grace period - which may be up to 21/2 months after the end of the plan year - unused salary reduction contributions attributable to plan years beginning in 2012 will not count against the $2,500 limit for the 2013 plan year. Other important highlights include:

* Plan sponsors may adopt the required amendments to reflect the $2,500 limit at any time through the end of the 2014 calendar year. Although cafeteria plan amendments may only be made effective prospectively, the IRS will permit plan sponsors to make retroactive amendments to conform their cafeteria plans to PPACA's $2,500 limit, provided that their plans operate in accordance with the limit for plan years beginning after December 31, 2012.

* Relief is provided for certain salary reduction contributions exceeding the $2,500 limit that are due to a reasonable mistake (not willful neglect) and that are corrected by the employer. If a cafeteria plan is amended to reflect the $2,500 limit, but an employee is erroneously permitted to elect a salary reduction of more than $2,500 for a plan year, such a mistake will not necessarily result in a disqualification of the cafeteria plan under the Internal Revenue Code, provided that the employee's salary reduction contributions in excess of $2,500 are paid to the employee and included in the employee's taxable income.

* The $2,500 limit applies only to salary reduction contributions under a health FSA, and not to employer contributions (i.e., flex credits). In addition, the $2,500 limit does not apply to amounts available for reimbursement under other types of FSAs (e.g., dependent care assistance or adoption care assistance plans), health savings accounts or health reimbursement arrangements.

* If a cafeteria plan has a short plan year (that is, fewer than 12 months) that begins after 2012, the $2,500 limit must be prorated based on the number of months in the plan year.

* The $2,500 limit on salary reduction contributions applies on an employee-by-employee basis. Therefore, the $2,500 limit is the maximum salary reduction contribution that each employee may make for a plan year, regardless of the number of dependents whose medical expenses are reimbursable under the employee's health FSA.

* All employers that are treated as a single employer under the Internal Revenue Code's controlled group rules will be treated as a single employer for purposes of the $2,500 limit. Therefore, if an employee participates in multiple health FSAs maintained by members of a controlled group, the employee's total health FSA reduction contributions under all such health FSAs will be limited to $2,500.

 

Administrative relief

IRS Notice 2012-40 also requests comments (the deadline for which has passed) on possible modifications to the "use-or-lose" rule currently applicable to health FSAs. Under the use-or-lose rule, health FSA participants are generally prohibited from using any benefit or contribution under a health FSA in a subsequent plan year. Thus, unused amounts in health FSAs are forfeited at the end of the plan year. As the $2,500 limit decreases the potential for using health FSAs to defer compensation, the IRS is considering whether the use-or-lose rule should be modified to provide a different form of administrative relief. The IRS has also requested comments on how any modification to the use-or-lose rule would interact with the $2,500 limit.

Contributing Editor Kate Bongiovanni is an associate in the tax section of Smith, Gambrell & Russell, LLP. She can be reached at kbongiovanni@sgrlaw.com.

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Healthcare plans Compliance
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