IRS Issues Guidance on 2013 Limit on Health Flexible Spending Arrangements IRS Issues Guidance on 2013 Limit on Health Flexible Spending Arrangements

IRS Issues Guidance on 2013 Limit on Health Flexible Spending Arrangements

The Patient Protection and Affordable Care Act of 2010 (PPACA) amended Section 125 of the Internal Revenue Code (Code) to place a $2,500 limit on salary reduction contributions to health flexible spending arrangements (health FSAs). PPACA provides that the $2,500 limit is effective for taxable years beginning after Dec. 31, 2012, and the limit is indexed for inflation for taxable years beginning after Dec. 31, 2013 (referred to generally as the "$2,500 limit"). The Internal Revenue Service (IRS) recently issued Notice 2012-40 to provide guidance regarding the administration of the $2,500 limit, including the meaning of "taxable year" for purposes of this provision.
 
Notice 2012-40 provides the following guidance to employers that sponsor a Code Section 125 cafeteria plan that offers a health FSA:
 
  • Effective date of provision. The $2,500 limit applies to the first plan year beginning after Dec. 31, 2012. Thus, the IRS has interpreted "taxable year" under this provision to mean plan year. This means that an employer whose health FSA runs on a calendar year will have to impose the $2,500 limit for the plan year that begins Jan. 1, 2013. An employer whose health FSA has a plan year that begins July 1 will have to impose the limit for the plan year that begins July 1, 2013. In addition, the $2,500 limit will be indexed for inflation and may increase for plan years beginning after Dec. 31, 2013. Note that an employer may continue to impose a lower limit, as specified in the plan document, but in no case may it exceed $2,500 (as indexed for inflation).
  • Limit applies exclusively to health FSA salary reduction contributions. The $2,500 limit applies only to salary reduction contributions under a health FSA. As such, the limit will not apply to the following types of contributions:
    • Employer non-elective contributions (sometimes referred to as "flex credits") made to an employee's health FSA. Note that if an employee is able to choose between the flex credits and cash, the flex credits are treated as salary reduction contributions and do count against the $2,500 limit.
    • Contributions to a health savings account or health reimbursement account.
    • Contributions to other types of FSAs, including dependent care assistance and adoption assistance.
    • Salary reduction contributions made by employees to pay their share of health coverage under the employer's group health plan.
  • Limit applies separately to each eligible employee of an employer. Each eligible employee of an employer may elect the $2,500 limit, regardless of the number of other individuals whose medical expenses are reimbursable under the employee's health FSA (i.e., the number of dependents covered by the health FSA does not affect the limit). If two spouses employed by the same employer are each eligible to participate in the employer's health FSA, each spouse may separately elect the $2,500 limit. In addition, if an employee is eligible to participate in a health FSA through two unrelated employers, the employee may elect the $2,500 limit under both employer's plans. Controlled group rules apply to treat related employers as a single employer for purposes of this provision.
  • Short plan years must prorate limit. The limit applicable to a short plan year beginning after Dec. 31, 2012, must be prorated based on the number of months in that short plan year. Note that a cafeteria plan year may only be changed for a "valid business purpose" under the Code Section 125 plan rules. The guidance makes clear that changing the plan year for the principle purpose of delaying application of the $2,500 limit is not a valid business purpose, and the attempted plan year change would not be given effect.
  • Contributions used during a plan year's grace period do not count against the subsequent plan year's limit. If a plan provides for a grace period, unused salary reduction contributions to the health FSA for the plan year that are carried over into the grace period do not count against the $2,500 limit applicable for the subsequent plan year. For example, a calendar year plan that includes a grace period may provide that employee salary reduction contributions for the health FSA are limited to $5,000 for the 2012 plan year. Effective for the 2013 plan year, the plan provides that employee salary reduction contributions to the health FSA are limited to $2,500. Under this example, some employees may have unused amounts from their 2012 health FSA salary reduction contributions that remain available during the grace period in the beginning of 2013. The guidance provides that the availability during the grace period of amounts attributable to 2012 health FSA salary reduction contributions does not cause the cafeteria plan to fail to satisfy the $2,500 limit.
  • Requirement to amend cafeteria plans. A cafeteria plan offering a health FSA must be amended to set forth the $2,500 limit (or lower limit, if desired by the employer) by Dec. 31, 2014. This amendment may be made retroactively back to the first plan year that began after Dec. 31, 2012, as long as the plan actually applied the $2,500 limit since that time.
  • Mistakes in applying limit may be forgiven. The guidance provides relief for erroneous salary reduction contributions made in excess of the $2,500 limit during a plan year if certain requirements are met. The relief requires the employer to report salary reduction contributions in excess of the limit as taxable wages on the employee's Form W-2 for the employee's taxable year in which, or with which, ends the plan year in which the correction is made.
Ice Miller LLP has been tracking the regulations and other guidance issued under PPACA, and you can read about the guidance that has been issued to date on Ice Miller's Health Care Reform website.
 
For more information about PPACA employer responsibilities or any employee benefits matter, contact Mary Beth Braitman, Melissa Proffitt Reese, Christopher S. Sears, Tara Schulstad Sciscoe or Shalina A. Schaefer.
 
This publication is intended for general information purposes only and does not and is not intended to constitute legal advice. The reader must consult with legal counsel to determine how laws or decisions discussed herein apply to the reader's specific circumstances.
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