IRS May Eliminate FSA Use-It-or-Lose-It Rule

Employers and plan administrators that offer health flexible spending accounts have been bracing themselves for Jan. 1, 2013. That’s when the $2,500 limit on health FSA salary reduction contributions provided for in the Patient Protection and Affordable Care Act kicks in. The IRS on May 30 issued Notice 2012-40, which provides guidance on the limit, as well as how the PPACA will affect FSAs in other ways.

One of the greatest concerns over the Jan. 1, 2013 effective date for the salary reduction limit is how non-calendar year plans would comply. Much to employers’ relief, the IRS said the $2,500 annual FSA contribution cap set by the Patient Protection and Affordable Care Act will not apply for plan years that begin before Jan. 1, 2013. For example, a plan that has a July1-June 30 plan year will not have to apply the $2,500 limit until Jan. 1, 2013.

As for the $2,500 limit itself, it only applies to salary reduction contributions. The limit does not apply to health reimbursement arrangements, health savings accounts, dependent care FSAs and adoption assistance.

The notice also contains good news regarding terminology in Code Section 125(i), which the PPACA created, which referred to “taxable years.” The IRS says that this term can be taken to mean “plan year,” an interpretation that means that administrators of non-calendar year plans will not have to track salary reductions for each calendar year.

There is good news for employers that offer grace periods, too. The IRS says in the notice that amounts carried over in a grace period that extends from the 2012 plan year do not count toward the $2,500 limit for the 2013 plan year.

The IRS is showing additional mercy to administrators: the deadline by which they must amend cafeteria plans to reflect the new limit is Dec. 31, 2014.

The notice also suggests that is possible that the “use-it-or-lose-it” rule, which states that unused FSA funds from the previous year must be forfeited at the start of the next, may be modified. The IRS has invited written comments on that matter and will accept them through Aug. 17.