On May 30, 2012, the U.S. Department of the Treasury issued Notice 2012-40, which interprets the new limit imposed on salary reduction contributions to health flexible spending arrangements (health FSAs) under section 125(i) of the Internal Revenue Code and seeks comments on possible modifications to the longstanding “use-it-or-lose-it” rule for health FSAs.

Section 125(i), which was added to the Code by section 9005 of the Patient Protection and Affordable Care Act, provides that a health FSA is not treated as a qualified benefit under section 125 unless the cafeteria plan “provides that an employee may not elect for any taxable year to have salary reduction contributions in excess of $2,500 made to such arrangement.” Employers and others asked many questions about how to implement this contribution limit, particularly with respect to cafeteria plans with a non-calendar plan year.

Notice 2012-40 supplies answers to many important questions. It provides that...

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