IRS Prescribes Rules for Health Care FSAs

By Ken Berry

A new IRS ruling (Notice 2012-40) provides guidance on a pending limit for flexible spending accounts (FSAs). Beginning in 2013, the amount that a participating employee can contribute to an FSA for health care expenses is limited to $2,500 (thereafter indexed for inflation). Currently, there's no such limit for health care FSAs.

But there is one extenuating factor to consider: The limit was included in the 2010 health care law ‒ the Patient Protection and Affordable Care Act (PPACA). The US Supreme Court is expected to issue its decision on the constitutionality of the PPACA any day now. Its ruling may have an impact on the FSA limit for 2013.
 
To quickly review: An employer may allow employees to contribute a portion of salary to an FSA on a pre-tax basis, thus saving tax dollars. Any distributions used to pay for qualified medical costs are exempt from federal income tax, but other distributions are taxable. 
 
Typically, contributions are made through regular payroll deductions, based on the annual amount specified before the start of the year. However, any amount left over at the end of the year is forfeited, although an employer may grant a 2½-month "grace period" for carrying over funds to the next year. 
 

Talking Points

  • Employees should be informed by employers of the value of using FSAs on a pre-tax basis.
  • Participants need to make a careful analysis of their unreimbursed health care costs before the start of each year.
  • Participants should try to schedule year-end doctor and dentist visits to absorb funds in their accounts.
  • Beginning in 2013, participants may want to maximize contributions. 
  • Employers may want to establish a 2½-month grace period to give participants more time to empty out their accounts.
The new IRS Notice clarifies the following points: 
  • The $2,500 limit is effective for plan years beginning after 2012. Also, an employer can't change its plan year to delay imposition of the $2,500 limit.
  • The $2,500 limit applies individually. Therefore, a married couple may contribute a maximum of $5,000.
  • If a short plan year begins after 2012, the $2,500 limit is prorated, based on the number of months in the short plan year.
  • All employers in a controlled or affiliated service group are treated as a single employer for application of the $2,500 limit.
  • The $2,500 limit only applies to salary reduction contributions to an FSA. No limit applies to employer nonelective contributions, such as flex credits, unless the employee can choose between receiving the flex credits as cash or a taxable benefit.
  • If an employer uses the 2½-month grace period for plan years beginning in 2012 or later, any amount carried over to the next year doesn't count against the $2,500 limit for the subsequent year.
  • If an employee is allowed to elect to contribute more than $2,500, the plan won't lose its tax-favored status as long as: (1) the terms of the FSA apply uniformly to all participants, (2) the mistake is inadvertent and not due to the employer's willful neglect, and (3) the excess contributions are returned to the employee and reported as taxable wages.
 
The IRS is also requesting comments on the "use-it-or-lose-it" feature of FSAs. This provision may be modified or eliminated in the future.
 

 

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