In a recent Notice, the IRS provided guidance on the effective date of the $2,500 limit on salary reduction contributions to health flexible spending arrangements (“Health FSAs”) and on when plans should be amended to comply with the limit

Background. Under the Patient Protection and Affordable Care Act (“PPACA” or “Health Care Reform”), the annual contributions permitted for an employee under the Health FSA component of a Cafeteria Plan will be capped at $2,500. This is effective for “taxable years” beginning after Dec. 31, 2012.

New guidance. Notice 2012-40 provides the following guidance and clarifications regarding the $2,500 limit.

  • The $2,500 limit does not apply for plan years that begin before 2013.
  • The term “taxable year” refers to the plan year of the cafeteria plan (and not the tax year of the employee or employer). This means the period for which salary reduction elections are made.
  • If a cafeteria plan has a short plan year beginning after 2012, the $2,500 limit must be prorated accordingly.
  • The $2,500 Health FSA cap does not apply to any other “flex credit” offered under a Cafeteria Plan (such as dependent care assistance).
  • Plans may adopt the required amendments to reflect the $2,500 limit at any time through the end of calendar year 2014, provided that they otherwise operate in accordance with the new limit requirements.
  • In the case of a plan providing the optional grace period, unused salary reduction contributions to the health FSA for plan years beginning in 2012 or later that are carried over into the grace period for that plan year will not count against the $2,500 limit for the subsequent plan year.
  • If one or more employees are erroneously allowed to elect a salary reduction exceeding the Health FSA limit, the Cafeteria Plan will not lose its qualified status if: (1) the terms of the Plan apply uniformly to all participants, (2) the error was a reasonable mistake and not due to willful neglect, and (3) the excess amount is paid to the employee and treated as taxable wages.