IRS Releases Guidance on the $2,500 limit for Salary Reduction Contributions Under Health FSAs

Health care reform imposes a $2,500 limit on annual salary reduction contributions to health Flexible Spending Accounts (“health FSAs) offered under cafeteria plans, effective for taxable years beginning after December 31, 2012 As provided in Section 125(i)(1) of the Internal Revenue Code (the “Code”), the $2,500 amount is indexed for inflation for taxable years beginning after December 31, 2013.

On May 30, 2012, the IRS released Notice 2012-40 which provides guidance on the effective date of the $2,500 limit on salary reduction contributions to health FSAs and on the deadline for amending plans to comply with that limit. This notice also provides relief for certain contributions that mistakenly exceed the $2,500 limit and that are corrected in a timely manner.

Specifically, Notice 2012-40 provides that:

• The $2,500 limit does not apply for plan years that begin before 2013;
• If the a cafeteria plan has a short plan year, the $2,500 limit must be prorated based on the number of months in the short plan year
• The term “taxable year” in Code Section 125(i) refers to the plan year of the cafeteria plan as this is the period for which salary reduction elections are made;
• The $2500 limit is applied on an employee-by-employee basis and is applied separately for each unrelated employer that an individual may be working for during the year;
• Plans may adopt the required amendments to reflect the $2,500 limit at any time through the end of calendar year 2014;
• In the case of a plan providing a grace period (which may be up to two months and 15 days), unused salary reduction contributions to the health FSA for plan years beginning in 2012 or later that are carried over into the grace period for that plan year will not count against the $2,500 limit for the subsequent plan year; and
• 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 statutory $2,500 limit under Code Section 125(i) applies only to salary reduction contributions under a health FSA, and does not apply to certain employer non-elective contributions (sometimes called flex credits), to any types of contributions or amounts available for reimbursement under other types of FSAs, health savings accounts, or health reimbursement arrangements, or to salary reduction contributions to cafeteria plans that are used to pay an employee’s share of health coverage premiums (or the corresponding employee share under a self-insured employer-sponsored health plan).

A copy of Notice 2012-40 is provided by clicking on the link below:

http://www.irs.gov/pub/irs-drop/n-12-40.pdf

Source: Larry Grudzien, Attorney