Benesyst FSA Compliance Alert - June 1, 2012

IRS Guidance on Healthcare Flexible Spending Accounts

The IRS has issued Notice 2012-40 providing information regarding the $2,500 annual limit on Healthcare FSA salary reductions under §125(i) of the Internal Revenue Code. Major clarifications from this notice include:

  • The $2,500 limit only applies to plan years that begin after December 31, 2012.

  • The term "taxable year" as defined in PPACA refers to the plan year of the cafeteria plan as this is the period for which salary reduction elections are made.

  • Plans may adopt the required amendments to reflect the $2,500 limit at any time through the end of calendar year 2014. 

  • For plans offering a Grace Period, unused contributions to the Healthcare FSA for plan years beginning in 2012 or later will not count against the $2,500 limit for the subsequent plan year.

  • Employer contributions to a Healthcare FSA generally do not count against the limit. (If the employee may elect to receive the employer contributions in cash or as a taxable benefit, then the contributions will be treated as salary reductions and will count toward the limit.) 

  • Relief is provided for certain salary reduction contributions exceeding the $2,500 limit that are due to a reasonable mistake and not willful neglect and that are corrected by the employer.

  • The Treasury Department and the IRS are considering whether the use-it-or-lose-it rule for Healthcare FSAs should be modified to provide a different form of administrative relief (instead of, or in addition to, the current Grace Period rule). Comments are requested on whether the proposed regulations should be modified to provide additional flexibility.

Benesyst Commentary

This notice provides much needed clarification to the "taxable year" language in PPACA. We are encouraged that employer contributions and salary reductions from a prior plan year's Grace Period do not count against the cap. 

The notice does not address those employers with mid-year plans that have already made adjustments to their 2012 plan (which is no longer impacted by the limit). We are consulting with our legal counsel on available options (whether they can "re-offer" their prior annual election or provide another form of remedy). Please contact your Account Manager with questions or to discuss options.

Regarding the "Request for Comments", we are strong believers that the "use-it-or-lose-it" rule discourages participation in Healthcare FSAs and needlessly harms employees who participate. It is our belief that the optimal remedies would be: (1) any remaining balance at the end of the plan year can go to the employee as taxable income, or (2) any remaining balance at the end of the plan year could be carried over to the following plan year and not count against the cap. We intend to advise the IRS and Treasury department to this end and encourage employers to do the same.

Going Forward

We expect further guidance from both the IRS and our legal counsel and we will communicate any changes via Client Alerts and through your Account Manager


Should you have any questions regarding the limit, the impact to your plan, or questions on plan documents, please contact your Account Manager.   


The Benesyst Team

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