The Patient Protection and Affordable Care Act modified the rules relating to cafeteria plans to impose a new $2,500 annual limit on the amount that an employee may elect to contribute to a health flexible spending account (“health FSA”), effective January 1, 2013. The modification came in the form of new Section 125(i) of the Internal Revenue Code, and the IRS recently issued Notice 2012-40 to explain the new rules. Many of our clients have asked us to explain how the new $2,500 limit will work.
Annual Limit Applies on a Per Employee Basis
Under Code Section 125(i), the new limit applies on a plan year basis and on a per employee basis. If two spouses (or a parent and child) are both employed by a single employer (“Employer X”) or a member of Employer X’s controlled group of businesses, then each spouse (or child, if applicable) may contribute the full $2,500 to the health FSA sponsored by Employer X or another member of the controlled group. The $2,500 limit, however, applies no matter how many dependents for whom the employee seeks reimbursement under the health FSA. Thus, the $2,500 limit applies to an employee with single or family health coverage.
If an employee participates in more than one cafeteria plan in a controlled group of businesses with Employer X, then the employee’s total contributions to one or more health FSAs sponsored by controlled group members may not exceed $2,500. In contrast, if the employee is employed part-time by Employer X and part time by another employer who is not a member of Employer X’s controlled group, then the employee may defer the full $2,500 to each employer’s health FSA.
Note that the dollar limit will be indexed for cost-of-living adjustments for plan years beginning after December 31, 2013.
Applies Only to Salary Reduction Contributions to a Health FSA
The new $2,500 annual limit applies only to employee salary reduction contributions. It does not apply to employer non-elective contributions (i.e., flex credits). For example, if the employer contributes a $500 flex credit to each employee’s health FSA for the 2013 plan year, then each employee may still elect to make salary reduction contributions of $2,500 to a health FSA for that plan year. If, however, the employer provides flex credits that employees may elect to receive as cash or as taxable benefits, then those flex credits are treated as salary reduction contributions for purposes of the $2,500 limit.
The new limit does not apply to other types of FSAs (adoption or dependent care FSAs), health savings accounts, or health reimbursement arrangements. In addition, the new limit does not apply to salary reduction contributions used to pay health insurance premiums (or the employee share of contributions under a self-insured employer-sponsored health plan).
Application to Health FSAs with Grace Periods
Some employers have adopted grace periods for their health FSAs that permit an employee to carryover unused salary reduction contributions to the health FSA to a subsequent plan year. The unused contributions that are carried over must be used within the grace period established by the employer under the health FSA not to exceed 2-1/2 months. IRS Notice 2012-40 provides that contributions for 2012 that are not used by the end of 2012 and are carried over into 2013 pursuant to an established grace period will not count against the $2,500 limit for the 2013 plan year.
Plan Amendment Deadline
Despite the imminent effective date of the new rules, an employer may adopt the required amendment to reflect the $2,500 limit at any time through the end of calendar year 2014.