The IRS issued Notice 2012-40 regarding the $2,500 flexible spending account (FSA) limit enacted by Health Care Reform
Bottom Line:
- The limit applies to plan years beginning after December 31, 2012
- Plans may adopt amendments at any time through the end of 2014
- For plans with a grace period, amounts carried over will not apply to the $2,500 limit
- Relief may be available for reasonable errors in applying the $2,500 limit
The Notice – providing welcome news
The Patient Protection and Affordable Care Act (PPACA) added a $2,500 limit (with cost of living adjustments for plan years beginning after December 31, 2013) on salary reduction contributions for “taxable years” beginning after December 31, 2012. The use of the phrase “taxable year” was of concern since cafeteria plan elections are based on the “plan year”.
The clarification that “taxable year” means “plan year” is welcome news.
Plans with off calendar year plan years were anticipating administrative and communication gymnastics regarding a limit that could potentially straddle the $5,000 limit in 2012 and the $2,500 limit in 2013. Likewise, the clarification that the $2,500 limit applies to plan years beginning after December 31, 2012 is welcome news.
Plans that provide a 2 ½ month grace period will be relieved to know that carryovers from the 2012 plan year will not count toward the $2,500 limit.
The $2,500 limit applies to salary reduction contributions and not to non-elective contributions (e.g., employer provided flex-credits) unless the employee may elect to receive the flex-credits as cash or a taxable benefit.
The $2,500 limit does not apply to:
- Salary reduction contributions that are used to pay the employee’s share of the health coverage contributions,
- Health Savings Account contributions,
- Health Reimbursement Account contributions or
- Dependent care spending account contributions.
If a reasonable error happens in applying the $2,500 limit resulting in deferrals above the limit, the excess salary reductions can be paid to the employee and reported as income on the employee’s W-2. However, this relief is only available if the employer is not under examination with respect to the cafeteria plan for the plan year to which the error occurred. An employer is considered under examination if a written notification (e.g., plan examination, information data request, or notification of proposed adjustments to a federal tax return) has been received.
The limit is applied on an employee basis; therefore, if an employee and spouse are each eligible as employees, the $2,500 limit applies separately to each employee.
However, the $2,500 limit is applied on a controlled group basis; if an employee works for more than one employer in the controlled group, the employee’s maximum salary deferral is $2,500 in total.
Generally, cafeteria plan amendments may be effective on a prospective basis only. However, an amendment for purposes of the $2,500 limit may be made retroactively provided the plan has been operating in compliance with limit and the amendment is adopted on or before December 31, 2012.
The Notice cautions that a plan year can only be changed for valid business reasons; changing the plan year to postpone application of the rule is not a valid business reason.
Request for Comments
The IRS is considering whether the “use it or lose it” rule should be modified. This rule was implemented to prevent employees from deferring compensation from one year to the next. Given the limit reduction, the ability to defer significant amounts of compensation is reduced.
The IRS is seeking comments regarding whether the “use it or lose it” rules should be modified to provide more flexibility. Comments must be submitted by August 17, 2012.
What should Plan Sponsor’s do:
- It depends on the Supreme Court’s decision regarding health care reform.
- If your open enrollment material must go to print before the Supreme Court decision regarding health care reform make sure your 2013 open enrollment material explains the new limit and how it will apply to your plan.
- Review your plan document to determine if an amendment is necessary.
Note: all links are active as of the date of issuance of this ErisaALERT.
Disclaimer: This material is for the sole purpose of providing general information and does not under any circumstances constitute legal advice and should not be used as a substitute for legal advice. You should seek the advice of counsel when applying the requirements to your plan. For more information on this ErisaALERT contact us by phone at 610-524-5351 and ask for Mary Andersen or 973-994-7539 and ask for Theresa Borzelli.
