IRS Publishes Clarification on New Section 125 Limits for Health FSA’s

Contributed by Rebecca Dobbs

One of the myriad of requirements contained within Health Care Reform is a dollar limitation on health flex-spending account contributions. The new rule caps maximum health FSA contributions at $2500 beginning with the 2013 tax year. Prior to this rule going into effect, there is no cap on how much an employee can contribute to a health FSA. Rather, employer/plan sponsors are free to determine an appropriate cap on contributions and incorporate that cap within their plan documents. Other considerations typically come into play causing a plan to set limits anywhere below $5,000 per plan year.

Confusion arose in that the new $2500 limitation was set to begin with the 2013 tax year, i.e., January 1, 2013. Not every health FSA, however, has a plan year that coincides with the calendar year. This meant some plan sponsors were struggling with how to amend their plans and when to incorporate the change to ensure that participants did not inadvertently over-contribute beyond the $2,500 limit.

As with almost every provision of Health Care Reform, clarification was needed from the appropriate agency charged with interpretation – in this case, the IRS. Earlier this month, the IRS published Notice 2012-40 providing such clarification. In this Notice, the IRS clarified a few important issues.

First, Notice 2012-40 clarifies that the “taxable year” refers to the plan year of the health FSA plan and not the individual employee’s “taxable year.” This clarification should provide quite a bit of relief for plan sponsors administering plans that are not operating on a calendar year basis.

A second key point clarified is that the $2,500 limit applies to all employee participants regardless of the number of dependents who can be reimbursed for medical expenses through the employee’s participation in the plan. That said, if each spouse is eligible to contribute to a health FSA, they can each separately contribute up to the $2,500 maximum.

The Notice also gives an exception to the general rule that plan amendments can only be made on a prospective basis. Accordingly, employer/plan sponsors now have until December 31, 2014 to adopt appropriate plan amendments bringing them into compliance for all plan years beginning after December 31, 2012. The Notice also spells out a method for correction in the event a plan sponsor makes a “reasonable” mistake resulting in an employee over-contributing to the plan.

All employers sponsoring health FSA’s should review their current plan and limits to determine if amendments are required and whether open enrollment materials need to be revised.