The IRS recently issued Notice 2012-40 which provided much needed guidance on the $2,500 contribution limit for health FSAs effective in 2013. Prior to Notice 2012-40, it was unclear whether the $2,500 limit applied on a calendar year basis or a plan year basis which created uncertainty in administering the limit for non-calendar year plans. Now, IRS guidance clarifies that the $2,500 limit applies on a plan year basis with the first plan year beginning on or after January 1, 2013.
The IRS provided the following additional guidance:
- The $2,500 limit applies to employee salary reduction contributions and employer contributions (i.e., "flex credits") contributed to a health FSA that an employee could have elected to receive in cash. Flex credits contributed to an employee's health FSA that an employee could not elect to take in cash are not counted toward the $2,500 limit.
- For plans that include a grace period for unused health FSA contributions, the amounts carried over into the grace period will not count against the $2,500 limit for the subsequent plan year.
- Plans must be amended to comply with the new limit by December 31, 2014 for both calendar and non-calendar year plans. Keep in mind, however, administration of the $2,500 limit must begin with the first plan year beginning on or after January 1, 2013.
- Relief is available for contributions that exceed the $2,500 limit because of a reasonable mistake if corrected by employer. Correction involves paying the excess to the employee and reporting the amount as wages on the employee's Form W-2.
In light of the $2,500 limit, the IRS is considering modifying the "use-it or lose-it" rule (which prohibits unused health FSA contributions from being carried over and used in subsequent plan years except during a grace period) to provide greater flexibility for using health FSA contributions. Any change in the use-it or lose-it rule would be a significant development for health FSAs. Stay tuned for any future developments in this area.