IRS Provides Much Needed Guidance for Health FSAs

Author: Jason A. Rothman (Cleveland)

Employers are getting some welcome relief in the form of IRS guidance that provides helpful details and clarity on how to implement the upcoming $2,500 limit on salary reduction contributions to health flexible spending accounts (FSAs) set by the Patient Protection and Affordable Care Act (PPACA).

Notice 2012-40, which was issued by the IRS on May 30, 2012, also provides a generous deadline for amending cafeteria plans to reflect this new limit – before year-end 2014 – and indicates that the Treasury Department and IRS are considering modifying the “use-it-or-lose-it” rule that has long troubled health FSA participants.

Background

The PPACA affects health FSAs in several ways. For example, it adds Internal Revenue Code Section 125(i), which imposes a $2,500 limit on salary reduction contributions to health FSAs effective for “taxable years” beginning after December 31, 2012. The $2,500 limit will be indexed for inflation in future years (beginning December 31, 2013).

The PPACA requirements sometimes overlap with proposed cafeteria plan regulations that the IRS issued in 2007. These proposed regulations contain very explicit and detailed requirements as to what must be included in a written cafeteria plan document. One requirement is to specify the maximum amount of salary reduction contributions that may be made to a health FSA. The proposed regulations generally require plan amendments to be adopted prior to the date when they become effective. The proposed regulations also contain the “use-it-or-lose-it” rule, which generally prohibits contributions under a health FSA from being used in a subsequent plan year or period of coverage. Failure to satisfy these rules would trigger disqualification of the entire arrangement resulting in significant tax consequences. The issuance of final regulations is on the Treasury agenda, and plan sponsors must be aware of the impact they will have on their cafeteria plans and health FSAs.

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