HR & Benefit News

Guidance Released Regarding FSA $2,500 Limit

The anticipation of how to handle the Health Flexible Spending Account (FSA)’s new employee salary reduction limit has come to an end.  The Internal Revenue Service (IRS) released Wednesday, Notice 2012-40, which outlines specific guidelines to the implementation of the effective date of the $2,500 limit under Section 125. 

The most important factors Notice 2012-40 provides are:

• The $2,500 limit does not apply to plan years that begin before the year 2013
• The term, “taxable year”, refers to the plan year of the cafeteria plan in which salary reduction elections are made
• The plan may adopt the required amendments to reflect the $2,500 limit at any time through the end of the calendar year 2014
• If a plan provides a grace period, unused salary reduction contributions to the health FSA for plan years beginning in 2012 or later will not count against the $2,500 limit for the subsequent plan year.  (Grace periods may not be longer than two months and 15 days.)
• Relief is provided for certain salary reduction contributions exceeding the $2,500 limit that are due to a reasonable mistake and not willful neglect and that are corrected by the employer

The $2,500 limit on health FSA salary reduction contributions will begin after December 31, 2012.  It is important to note that the $2,500 limit will be indexed for cost-of-living adjustments for plan years beginning after December 31, 2013. 

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

The $2,500 limit is applied on an employee-by-employee basis, meaning each employee may contribute $2,500 to their Health FSA regardless of their spouse, children and/or dependents.  If each spouse participates in the same Health FSA which happens to be sponsored by the same employer, each member may contribute $2,500, for a total of $5,000. 

Please note that the $2,500 limit applies to employee contributions only.  An employer may contribute flex credits to employees with no effect on the employees’ limit, if the flex credits cannot be received as cash or as a taxable benefit.  If an employer wishes to contribute $1,000 in flex credits to employees, employees may still contribute $2,500 to their Health FSA so long as the flex credits do not fall against the rule stated previously. 

If an employer fails to be compliant before December 31, 2012, forgiveness may occur if:

a)     The terms of the plan apply consistently to all participants;

b)    The error results from a reasonable mistake by the employer (or the employer’s agent) and is not due to willful neglect; and

c)    Any salary reductions in excess of $2,500 are paid to the employee and reported as wages for income tax withholding and employment tax purposes on the employee’s Form W-2, Wage and Tax Statement (or Form W-2c, Corrected Wage and Tax Statement) for the employee’s taxable year in which, or with which, ends the cafeteria plan year in which the correction was made. 

What will happen to the “use-or-lose” rule”?

Because of the new limit, the Treasury Department and the IRS are considering if the Health FSA’s “use-or-lose” rule” should be modified.  Currently, any unused amounts in the health FSA are “forfeited” at the end of the plan year.  Now is the time to let your voice be heard!  Comments are now being requested on whether or not additional flexibility with respect to the “use-or-lose” rule” will be beneficial or not.  How should this be constructed or devised?  How would such alterations interact with the $2,500 limit?  Follow the directions below to submit your comments.

Comments must be submitted by August 17, 2012

All comments must include reference to Notice 2012-40

Mail submissions to:

CC:PA:LPD:PR (Notice 2012-40), Room 5203, Internal Revenue Service
P.O. Box 7604, Ben Franklin Station
Washington, DC 20044

Submissions may be hand delivered Monday through Friday between the hours of 8 a.m. and 4 p.m. to:

CC:PA:LPD:PR (Notice 2012-40), Courier’s Desk, Internal Revenue Service
1111 Constitution Avenue, NW
Washington, DC 20044

Send electronically to:

Notice.comments@irscounsel.treas.gov
Subject line must read: Notice 2012-40

Please note: all material submitted will be available for public inspection and copying.