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IRS Issues Guidance on $2,500 Limit for Salary Reduction Contributions to a Health FSA

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Lauren B. Dunn
Foster Swift Employment, Labor & Benefits Quarterly
Summer 2012

The Internal Revenue Service ("IRS") recently issued guidance regarding the $2,500 limit on salary reduction contributions to a health flexible spending account ("Health FSA") under the Patient Protection and Affordable Care Act ("PPACA"). IRS Notice 2012-40 clarifies that the $2,500 limit applies (generally effective January 1, 2013) to employee salary reduction contributions and does not apply to employer nonelective contributions to a Health FSA. Other important aspects of IRS Notice 2012-40 are described below.

Plan Year Basis. The $2,500 limit on salary reduction contributions to a Health FSA is effective for taxable years beginning after December 31, 2012. The Notice clarifies that the term "taxable years" refers to the plan year of the cafeteria plan under which the Health FSA is offered. Therefore, the $2,500 limit applies to plan years that begin after December 31, 2012. A cafeteria plan with a calendar plan year will have to comply with the limit beginning on January 1, 2013.

Short Plan Year. If a cafeteria plan has a short plan year (less than 12 months) that begins after December 31, 2012, the $2,500 limit must be prorated based on the number of complete months in that short plan year.

Per Employee Basis. The $2,500 limit applies on a per employee basis. Therefore, an employee and his or her spouse can each make Health FSA salary reduction contributions up to the $2,500 limit (even if the employee and his or her spouse work for the same employer and participate in the same Health FSA).

Grace Period. Unused salary reduction contributions from one plan year that are carried over into a grace period do not count against the $2,500 limit for the next plan year.

Amendment. Cafeteria plans must adopt an amendment to comply with the $2,500 limit on or before December 31, 2014. An amendment to comply with the limit that is adopted on or before December 31, 2014 may be effective retroactive to the first day of the 2013 plan year, if the cafeteria plan operates in accordance with the $2,500 limit for plan years beginning after December 31, 2012.

The Notice also provides that the Treasury Department and the IRS are considering whether the "use-it-or-lose-it" rule should be modified for Health FSAs. The $2,500 limit under PPACA reduces the (1) potential for using a Health FSA to defer compensation, and (2) extent to which salary reduction amounts may accumulate over time. The Treasury Department and IRS are accepting comments until August 17, 2012 regarding whether the use-it-or-lose-it rule should be modified, including how any modifications would interact with the $2,500 limit.

Please contact your Foster Swift employee benefits professional with any questions.