[author: Jeffrey Ashendorf]
Executive Summary: On May 30, the Internal Revenue Service issued Notice 2012-40, which, among other things, clarifies that the $2,500 limit on salary reduction contributions to health FSAs would not apply for plan years that begin before 2013.
One very popular employee benefit in recent years has been the healthcare flexible spending account (FSA), under which employees may elect to forego taxable salary and instead receive tax-free reimbursement of eligible healthcare expenses. As part of the "healthcare reform" enacted by the Patient Protection and Affordable Care Act (the "Act"), a $2,500 limit was placed on the amount of elective coverage (i.e., salary reduction contributions) that an individual could receive for a year under such a plan. The $2,500 limit was to be effective for "taxable years beginning after December 31, 2012"; in most cases, this would be for calendar year 2013.
On May 30, the Internal Revenue Service issued Notice 2012-40, which, among other things, clarifies that the $2,500 limit on salary reduction contributions to health FSAs would not apply for plan years that begin before 2013. In other words, for FSAs that provide coverage on the basis of a period other than the calendar year, the limit will not become applicable until the coverage year that begins in 2013. So if, for example, the plan has a plan year of July 1 through June 30, salary reduction contributions could be made without regard to the $2,500 limit through June 30, 2013; the $2,500 limit would first apply to the period July 1, 2013 – June 30, 2014.
Unfortunately, there are plans that have non-calendar plan years that have already begun, such as April 1 – March 31. In that situation, employees' elections for the year will have had to be made prior to April 1 and are not able to be changed. If the $2,500 limitation was applied on the basis that the plan year would extend into 2013, then employees were unnecessarily being limited. (The Notice also states that changing a plan year, though permitted for a "valid business reason," would not be permitted for the purpose of delaying the application of the $2,500 limit.)
FSAs are required to be amended to reflect the $2,500 limit, but, unlike most FSA amendments, those amendments may be adopted retroactively at any time before December 31, 2014, so long as the FSA is operated in compliance with the limit starting with the 2013 year.
The Notice also requests comments regarding whether to modify the "use-it-or-lose-it" rule that has been applicable to health FSAs. No change was actually made that would affect that rule, or enable balances to be carried over, but the IRS recognizes that, given the new $2,500 annual limitation, there is simply less potential for abuse of FSAs. Alternative suggestions to deal with unused balances, such as expanding the current 2-½ month "grace period," are invited.
If you have any questions regarding the Notice, FSAs or other employee benefits related matters, please contact Jeffrey Ashendorf, email@example.com, any member of Ford & Harrison's Employee Benefits practice group, or the Ford & Harrison attorney with whom you usually work.
 There are currently bills pending that, if passed, would repeal the ban on over-the-counter purchases and permit limited refunds (i.e., up to $500) of unused amounts. Those would obviously both assist in reducing or dealing with unused FSA balances.