The IRS recently released Notice 2012-40 (Notice), which provides guidance on the application of the cap. Below we answer some of the most frequently asked questions we have received regarding the ACA health FSA cap.
What is the effective date of the FSA cap?
The ACA states that the FSA cap is effective for "taxable years" beginning after December 31, 2012, but did not specify the applicable year to which it applies (i.e., the plan year or the employee's taxable year). The Notice clarifies that the FSA cap applies to "plan years" beginning after December 31, 2012.
When must an employer's cafeteria plan be amended to incorporate the FSA cap?
A cafeteria plan that offers a health FSA must be formally amended to reflect the cap, and cafeteria plan amendments generally may be effective only prospectively. The Notice provides welcome transition relief under which a cafeteria plan may be amended retroactively any time on or before December 31, 2014 to incorporate the cap, provided that the plan is operated in operational compliance with the cap after its 2013 plan year effective date.
Are employer flex credit contributions subject to the $2,500 cap?
In general, only employee salary reduction contributions are subject to the health FSA cap and employer "flex credit" contributions do not count against it. The Notice, however, provides that if an employer provides flex credits that employees may elect to receive as cash or as a taxable benefit, those flex credits will be treated as salary reduction contributions subject to the cap.
Is it possible that the health FSA "use-it-or-lose-it" rule could be modified in light of the new cap? Under the proposed cafeteria plan regulations, the so-called use-it-or-lose-it" rule generally prohibits contributions or benefits from being carried over to a subsequent plan year. Significantly, the Notice states that the IRS and Treasury Department are considering whether to modify the use-it-or-lose-it rule for health FSAs in light of the new $2,500 cap. The Notice states that the FSA cap "limits the potential for using health FSAs to defer compensation and the extent to which salary reduction amounts may accumulate over time." It requests comments as to whether the use-it-or-lose-it rule in the proposed regulations "should be modified to provide additional flexibility" as a result of the cap and, if so, how any such additional flexibility "might be formulated and constrained." Comments are due by August 17, 2012.