The IRS issued Notice 2012-40 yesterday (click here for the notice), providing a number of important clarifications regarding the $2,500 cap on health FSA contributions that applies beginning in 2013. The most surprising development is the IRS's interpretation that the cap applies on a plan-year basis, rather than a calendar-year basis. This is important for employers with fiscal-year plans. They will be able to wait until the first plan year beginning after December 31, 2012, to implement the cap, rather than using the transition rule or early implementation of the cap to ensure contributions during the 2013 calendar year do not exceed the cap, as was previously thought necessary.
Other key guidance points include:
- Clarification that unspent amounts carried over during a grace period will not count against the cap for the plan year in which the grace period occurs.
- Confirmation that the cap only applies to employee salary-reduction contributions to a health FSA. Employer contributions (e.g., flex credits) and salary-reduction contributions to dependent-care FSAs do not count, nor do amounts credited to HSAs or HRAs.
In addition to interpretive guidance, the Notice provides a limited correction rule that will allow fixing some good-faith mistakes. If a mistaken election to contribute more than $2,500 to a health FSA in a year is properly corrected, the error will not jeopardize the plan's status as a qualifying cafeteria plan.
Of academic interest, the Notice also requests comments on the use-it-or-lose-it rule. The implication is that the $2,500 cap may be low enough that concerns about excessive use of health FSAs to shelter otherwise taxable income are no longer warranted, which may justify allowing some carryover of unused amounts from year to year. For now, the use-it-or-lose-it rule remains the law, but employers should stay tuned for future developments.