The Affordable Care Act imposed a new limit on annual salary reduction contributions to health care flexible spending accounts (FSAs). The initial limit is $2,500 and it is indexed for inflation. This limit applies to all health care FSA plans in taxable years beginning January 1, 2013. But employers that use a fiscal year – rather than a calendar year – for their FSAs need to start implementing a plan now to address the new limits.
That is because for purposes of the 2013 dollar limit – the term “taxable year” refers not to the plan year but to the taxable year of the employee participating in the health FSA. Almost universally, this will be the calendar year. The first fiscal plan year that will overlap with 2013 begins February 1, 2012 (ending January 31, 2013). Fiscal year plans that currently permit salary reduction contributions in excess of $2,500 must ensure that such contributions occurring during the 2013 calendar year do not exceed the $2,500 cap.
Some important factors regarding this change are:
1. Limit applies to the tax (calendar) year and not the plan year. This is particularly important if your health care FSA plan does not operate on a calendar year basis you and your participants will need to track pre-tax contributions across the tax years just as you may currently do with Dependent Care Accounts.
2. The limit applies only to the employee salary reduction contribution amount. If your Plan offers an employer contribution, annual reimbursement amounts may exceed the $2,500 limit but only by the amount of the employer contribution. For example, the employee contributes $2,500 and the employer contributes $250. The employee is allowed to have an annual benefit amount of $2,750 for the tax year because of the employer contribution amount. For this purpose, until further guidance is provided by the IRS, employer contributions that may be cashed out or used for taxable benefits should be treated as an employee salary reduction contribution.
3. The limit applies on a per participant, per employer basis. Therefore, if a husband and wife both participate in their respective employer’s health care FSA plans, they may have a combined household pre-tax contribution of $5,000 for the taxable year but neither may contribute more than the $2,500 per person pre-tax limit (e.g. one cannot contribute $2,000 and the other contribute $3,000). In addition, if an employee is employed by two different employers (who are not part of a controlled group), each with a health care FSA, the employee could contribute up to $2,500 to each plan.
To simplify administration of this change, sponsors of non-calendar year plans may want to adopt the new limit as of the first day of the plan year beginning in 2012 rather than waiting until Jan. 1, 2013. For example, if the current plan year begins May 1 and ends April 30, the plan sponsor may:
- Initiate the changes to the contribution effective May 1, 2012, rather than wait until the mid-plan year in Jan. 1, 2013
- Communicate the change to employees.
Given these changes it is important for plan sponsors to make sure their plan documents and summary plan descriptions (SPDs) are in conformity.
Unless the IRS provides further guidance on this issue, there is nothing in the existing election change rules that would allow employees to reduce their elections on January 1, 2013, based upon the change in the law. Thus, if someone elected to contribute $5,000 to the health FSA and the plan year starts 7/1/12, typically 50% of the annual election will be contributed in 2012 and 50% will be contributed during the first half of 2013. That would mean this individual could not elect any benefits for the plan year beginning 7/1/13, because he/she has already contributed the full $2,500 in 2013.
In the absence of further guidance from the IRS providing some transition relief, if a fiscal year plan does not implement the limit in 2012, then the employer needs to track each individual’s contributions during the 2012 plan year and the 2013 plan year to ensure that contributions do not exceed the limit during the 2103 calendar year.