One of changes made by the Patient Protection and Health Care Act of 2010 was to place a $2,500 limit on salary-reduction contributions to medical flexible spending accounts (FSAs) beginning in 2013. IRS Notice 2012-40 provides long-awaited guidance about this $2,500 cap. One welcome piece of news is that the $2,500 cap does not apply to the 2013 calendar year, as originally stated in the law, but rather applies to cafeteria plan years beginning after 2012. As a result, employers whose FSA is run on a non-calendar plan year do not have to contend with the odd situation of having different dollar limits applying to different portions of the plan year.
The $2,500 cap will be indexed beginning in 2014 for changes in cost of living. For short plan years, the limit is prorated based on the number of months in the plan year. As an exception to the IRS’s general rule that cafeteria plan amendments cannot be made on a retroactive basis, plan sponsors have until December 31, 2014 to amend the plan to reflect the new cap, provided the plan operates in compliance with the cap for plan years beginning after 2012. Of course, open enrollment materials will need to be revised for the 2013 open enrollment period to reflect the new cap.
What Is (and Is Not) Subject to the Cap?
Dependent Care Accounts (DCAPs), Health Savings Accounts (HSAs), Health Reimbursement Accounts (HRAs), or premium conversion amounts, i.e., the pre-tax dollars participants use to pay their portion of cost for benefits, are not subject to the cap. Also, the cap does not apply to employer flex credits, as long as these employer contributions are not subject to participant direction. If a participant can direct the flex credits and elects to contribute the credits to his FSA, then such flex credits will count against the $2,500 cap. Also, if a cafeteria plan has a grace period (a period up to 2.5 months after the end of a plan year for which FSA balances remaining at the end of the prior year can be used to pay expenses incurred during the grace period), the dollars used to pay for grace-period expenses do not count against the $2,500 cap in place for the subsequent year. For example, a cafeteria plan’s plan year is the calendar and has a grace period that ends on March 15 after the end of the year; and the participant has a $500 unused FSA balance at the end of 2012. This $500 does not count against the $2,500 cap in place for 2013. Therefore, this participant can be reimbursed for up to $3,000 of medical expenses incurred in 2013.
Application of the Cap
If multiple cafeteria plans are offered within a controlled group or affiliated service group and an employee participates in more than one plan, a single $2,500 cap applies. But if an employee participates in multiple cafeteria plans sponsored by unrelated employers, a separate cap applies to each plan. If a husband and wife participate in the same plan, each spouse gets a separate cap. Finally, a single $2,500 cap applies to an FSA, regardless if the FSA reimburses the expenses incurred by multiple family members.
Relief for Excess Contributions
Relief is provided to plans, which through reasonable administrative error and not willful neglect, allow a few participants to exceed the cap. Contributions in excess of the cap must be paid to the participant as wages subject to income taxes and employment taxes for the calendar year that either coincides with the last day of the plan year or includes the last day of the plan year in which the excess occurred. However, if the employer is “under examination” with respect to the cafeteria plan for the plan year that includes the failure, relief is not available. An employer is under examination if the employer has received written notification of an examination, e.g., plan examination, an information document request, or notification of proposed adjustments to the employer’s federal tax return specifically citing the cafeteria plan. Because failure to comply with the cap results in the cafeteria plan’s loss of tax benefits, it is vital that the $2,500 cap be applied correctly.
Request for Comments on the “Use-It-or-Lose-It” Rule
In the Notice, the IRS asked for comments on the long-standing use-it-or-lose-it rule, a rule that results in the forfeiture of year-end unused balances. Comments are requested on whether and how the use-it-or-lose-it rule should be modified. Comments are due August 17, 2012.