IRS issues guidance on new $2,500 limit for health flex accounts

published in McAfee & Taft EmployerLINC Update | July 17, 2012

By John Papahronis

Beginning January 1, 2013, the Patient Protection and Affordable Care Act (PPACA) limits employee contributions to a health flexible spending arrangement (Health FSA) to $2,500 per year, as adjusted for inflation in subsequent years.

The IRS recently issued Notice 2012-40 (the Notice), which provides clarification and guidance on the application of the new $2,500 cap. The following is a summary of the major points in the Notice.

Effective Date of the $2,500 Cap. Prior to the Notice, it was unclear whether the $2,500 cap was effective for plan years or calendar years beginning after December 31, 2012. The Notice clarifies that the cap is effective for plan years beginning after December 31, 2012. Consequently, the limit will become effective for a calendar year Health FSA on January 1, 2013, and the limit will become effective for a fiscal year Health FSA on the first plan year that begins in 2013. Because of the uncertainty prior to the Notice, some employers with fiscal year Health FSAs chose to amend their plans to implement the $2,500 limit with the fiscal year beginning after December 31, 2012. Unfortunately, the Notice does not permit these employers to revoke or modify their early implementation of the cap in light of the new guidance in the Notice.

Employer Contributions. While employee salary reduction contributions to a Health FSA are subject to the cap, employer contributions are not. Thus, an employer “flex credit” to a Health FSA would not be subject to the cap, unless the employee is entitled to use the flex credit to elect cash or a taxable benefit.

Grace Periods. Health FSAs are permitted to include a 2½ month “grace period” following the end of the plan year, during which employees may use amounts remaining from the previous plan year to pay for medical expenses incurred during the grace period. The Notice provides that any unused amounts carried over to the grace period will not count towards the next plan year’s $2,500 cap.

Application of the Cap. The Notice provides that the $2,500 cap applies to each employee regardless of the number of the employee’s dependents. Further, the $2,500 cap applies on a controlled group basis, and therefore, if an employee participates in more than one Health FSA sponsored by the employer or a member of the employer’s controlled group, the employee is entitled to only one $2,500 limit. On the other hand, if the employee is employed by separate employers who are not related, the employee may be eligible for up to $2,500 under each employer’s Health FSA.

Plan Amendment. The Notice provides that Health FSAs must be amended to incorporate the new $2,500 by December 31, 2014. The amendment must, of course, be retroactive to the effective date of the cap.

Action Items. Employers who sponsor Health FSAs should consider the following action items as a result of the Notice guidance:

  • Revise summary plan descriptions, election forms, election materials and other employee communications to describe the $2,500 cap.
  • Make adjustments in payroll systems.
  • Consider whether to adjust the $2,500 cap in future years for inflation, or whether to maintain the limit at $2,500 for simplicity.
  • Review any employer contributions or flex credits to ensure compliance with the Notice.
  • Amend Health FSA documents by December 31, 2014, or consider amending the document sooner in order to ensure that this requirement is fulfilled.

If you should have any questions regarding the Notice or the new $2,500 cap on employee contributions to Health FSAs, please contact any member of the McAfee & Taft Employee Benefits Group.