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IRS Guidance on Applying the $2,500 FSA Salary Reduction Limit

June 18, 2012
Employee Benefits Alert

The Affordable Care Act (ACA) put a $2,500 cap on the amount participants could elect to put in a health care flexible spending account (FSA), effective as of 2013. Recently the IRS issued guidance on how this limit is to be applied, and the guidance provides employers a bit more breathing space.

New Rules for Health Care FSA Salary Reductions

Specifically, the recent IRS guidance provides that:

  • The $2,500 limit does not apply for plan years that begin before 2013. Thus, the limit applies on the first day of the plan year beginning on or after January 1, 2013. For calendar year plans this means that the limit will apply as of January 1, 2013, but for plans that end mid-year, the effective date will not be until the first day of the plan year beginning in 2013.
  • The ACA modification to Section 125 speaks of limiting the participant’s salary reduction election to $2,500 for “any taxable year.” The employee’s taxable year is likely the calendar year, and the taxable year may vary by employer. The IRS clarified that the term “taxable year” here means the plan year of the cafeteria plan.
  • The $2,500 cap will be indexed for inflation for plan years beginning after December 31, 2013.
  • The $2,500 limit for short plan years will be pro-rated based on the number of months in the short plan year.
  • The $2,500 limit on salary reductions applies on an employee-by-employee basis, regardless of the number of dependents whose medical expenses are reimbursable from the FSA. Spouses may each reduce their salaries by $2,500, whether they work for the same employer or for different employers.
  • The $2,500 limit applies to all health care FSAs sponsored by employers in the same controlled group of companies so that an individual who participated in health care FSAs sponsored by more than one related employer would have a single $2,500 limit applicable to all the FSAs combined, but an individual participating in FSAs of non-related employers would have a $2,500 limit for each FSA.
  • The $2,500 limit applies only to salary reduction contributions (though these are deemed to be employer contributions), but does not apply to direct employer non-elective contributions or employer-provided “flex credits.”
  • The $2,500 limit applies only to salary reduction contributions to health care FSAs, and does not limit the amount of salary reduction contributions that can be made to dependent care FSAs, adoption assistance programs or pre-tax payment programs that allow employees to pay for their share of group health plan premiums with pre-tax dollars.
  • If the cafeteria plan provides for a grace period, amounts available during the grace period from the prior plan year’s election do not count towards the $2,500 limit for the subsequent plan year.
  • If one or more employees are allowed erroneously to reduce their salaries by more than $2,500, the cafeteria plan will continue to be a qualified Section 125 plan if (i) the terms of the plan apply uniformly to all participants, (ii) the error results from a reasonable mistake by the employer, and (iii) the excess salary reduction amounts are paid to the employees and reported as taxable wages.
  • Though generally cafeteria plan amendments cannot be made with retroactive effect, an amendment to conform a cafeteria plan to the $2,500 health care FSA salary reduction limit adopted on or before December 31, 2014 may be made retroactively effective for a plan year beginning after December 31, 2012.

Action Steps

Employers should review their cafeteria plan documents and amend them to comply with this $2,500 health care FSA salary reduction limit.

If you have any questions about how best to prepare for, or respond to, these stricter COBRA audit Guidelines, any related aspects of COBRA administration, or any other employee benefit concerns, please contact one of our Employee Benefits attorneys.