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The Internal Revenue Service recently released Notice 2012-40
that provides guidance on the $2,500 annual limitation on salary
reduction contributions to health flexible spending accounts
("FSAs"), effective beginning in 2013. Interestingly, the
Notice also requests comments on a possible modification of the
use-or-lose rule with respect to FSA contributions.
In sum, the Notice clarifies the following:
Effective date: The $2,500 limit does not apply to
plan years beginning before 2013 and is computed with respect to
the cafeteria plan year.
Amendment deadline: Plans may adopt amendments
reflecting this change at any time through the end of calendar year
2014. Generally, cafeteria plan amendments may not be made
retroactively; however, amendments incorporating the $2,500
contribution cap adopted on or before December 31, 2014 may be made
retroactive to plan years beginning after December 31, 2012,
provided the plan has been operating in accordance with the law
change.
Application of the $2,500 limit: The $2,500 limit
applies on an employee-by-employee basis regardless of whether the
FSA also covers a spouse or dependents. If an individual is
employed by two, unrelated employers, that individual may make
salary reduction contributions of up to $2,500 under each
employer's FSA. For short plan years beginning after 2012, the
$2,500 limit should be prorated based on the number of months in
the short plan year. The limit may be indexed for cost-of-living
adjustments for plan years beginning on or after January 1, 2014,
and can still be written as the maximum applicable to a percentage
of compensation contribution formula.
Effect of grace period on $2,500 limit: For plans that
contain a grace period that permits unused FSA salary reduction
contributions to be carried into the next plan year (up to two
months and 15 days), these carryovers will not be taken into
account when computing the $2,500 limit.
Employer contributions: Non-elective employer
contributions to an FSA, sometimes called "flex credits,"
are not taken into account when computing the $2,500 limit, unless
they provide a cash or a taxable benefit option.
Corrections available for salary reduction contributions in
excess of $2,500 limit: If excess salary reduction
contributions are a result of a reasonable mistake and are not the
result of willful neglect, the Notice provides that the employer
may rectify the situation by reporting the excess contributions as
wages for income tax withholding and employment tax purposes on the
employee's Form W-2 for the employee's taxable year in
which the correction is made.
Finally, in light of the new $2,500 annual cap to salary
reduction contributions: the IRS has requested feedback on
potentially modifying the use-or-lose it rule under which employees
forfeit any unused FSA balance at the end of the cafeteria plan
year, plus any grace period—the rationale for such a
change being that the $2,500 limit prevents any material abuse in
terms of compensation deferrals.
Comments to Notice 2012-40 are due by August 17, 2012. Please
let us know if you would like us to submit comments on your
behalf.
This article is presented for informational purposes only
and is not intended to constitute legal advice.
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