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IRS Provides Guidance on $2,500 Limit on Health FSA Salary Reductions, Clarifies Application to Non-Calendar-Year Plans

From the May 31, 2012 EBIA Weekly

The IRS has issued much-anticipated guidance regarding the $2,500 annual limit on health FSA salary reduction contributions. Health care reform added this limit to Code § 125, effective for "taxable years beginning after December 31, 2012,” creating uncertainty over how this limit would apply to non-calendar-year plans. In addition to resolving this uncertainty, the guidance addresses other issues, such as which contributions are subject to the limit and timing of plan amendments. Key points for plan sponsors and administrators include the following:

• Plan Year Basis. The $2,500 limit applies on a plan year basis and is effective for cafeteria plan years beginning after December 31, 2012. In the case of a short plan year, the limit must be prorated. The limit is indexed for cost-of-living adjustments for plan years beginning after December 31, 2013. (Note from EBS: The IRS has defined the "taxable year” as the FSA’s plan year, which means that the $2,500 salary cap is effective for plan years beginning on or after January 1, 2013. The Notice from the IRS specifically indicates that "the $2500.00 limit does not apply for plan years that begin before 2013.”)

• Only Salary Reductions Count. Non-elective employer contributions to a health FSA generally do not count toward the limit. However, if employees 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 if contributed to the health FSA.

• Per-Employee Limit. The limit applies on a per-employee basis, regardless of how many other individuals’ medical expenses are reimbursable under the employee’s health FSA (e.g., a spouse or other family members). If spouses are each eligible to make health FSA salary reductions, then each spouse can make health FSA salary reductions up to the limit, even if they have the same employer and participate in the same health FSA.

• Multiple Health FSAs. If an employee participates in multiple health FSAs maintained by members of a controlled group or affiliated service group, then salary reductions to the health FSAs are aggregated and a single $2,500 limit applies. In contrast, if the employers are not related, then the employee may make salary reductions of up to $2,500 under each health FSA.

• Other Benefits. The $2,500 limit does not apply to contributions for other cafeteria plan benefits (such as salary reductions for the employee’s share of health coverage premiums, DCAPs, or HSAs), or to amounts made available by an employer under an HRA.

Please feel free to contact EBS if you have any questions or concerns.