In brief, fiscal year plans are not required to implement a Cafeteria Plan Year Health Care Spending Account $2,500 pre-tax contribution maximum until the first day of its 2013 plan year, based on IRS Notice 2012-40 published on May 30, 2012.
On January 24, 2012, we published the Compliance Alert: Flexible Spending Account (FSA) Limit of $2,500 Applies to 2012 Fiscal Year Plans describing the risk that a fiscal year (non-calendar) cafeteria plan with a health care spending account (FSA) could violate the health FSA maximum pre-tax benefit if a pre-tax benefit greater than $2,500 becomes available any month in 2013 on the basis that the Rule becomes effective January 1, 2013.
The Notice states that the Rule will apply on a plan year basis rather than on the employee tax year basis. So, for an FSA with a February 1, 2012 plan year, the plan pre-tax FSA maximum can remain in place for January 2013 even if it is greater than $2,500.
The Notice also provides the following additional information:
- Amendments. A plan may be amended to include the $2,500 pre-tax maximum at any time through the end of calendar year 2014.
- Grace Periods. Currently, cafeteria plans may permit participants to incur claims for up to 2-1/2 months following the end of the plan year. The Notice says that the IRS will not count the claims incurred during the grace period against the $2,500 maximum for the subsequent plan year.
- Reasonable Mistakes. If the plan has made a reasonable mistake and not due to willful neglect, the IRS will provide relief as long as the employer corrects the problem.
1. The Amendment.
Although the Notice allows employers to amend their plans to reflect the $2,500 pre-tax maximum any time before December 31, 2014, it is our recommendation that employers amend their plans before the beginning of their next plan year, if they have not done so already, to avoid any participant confusion.
2. Fiscal Year Plans Beginning February 1, 2012 or Later.
Based on guidance known at the time, some employers with fiscal year plans beginning February 1, 2012 and later (presumable plans whose fiscal year began prior to the IRS Notice on May 30, 2012), may have implemented the $2,500 maximum as of the beginning of its 2012 plan year or devised an elaborate administrative process to cut back the maximum as of January 1, 2013. Cafeteria plan regulations limit the reasons which permit an employer to allow participants an opportunity to change their elections mid-plan year (e.g. change in plan costs, etc). Although participants can change premium contribution amounts, none of those reasons permit an employee to change his/her health FSA amounts. Although we have no direct guidance, it is our view that employers whose 2012 plan years began February 2012 or later should not unwind the $2,500 pre-tax maximum as a result of the May 30, 2012 Notice.
3. Non-elective Contributions.
It is important to note that the $2,500 maximum is on an employee’s pre-tax election. The Notice points out that the maximum does not apply to employer non-elective contributions (e.g. the employer automatically contributes $500 to everyone’s health FSA).
4. The $2,500 Maximum is Per Participating Employee.
The Notice also makes it clear that the maximum amount an employee can elect on a pre-tax basis is $2,500 regardless of the number of eligible dependents.
If the FSA permits pre-tax elections in excess of the $2,500 limit, due to an administrative error (and not due to willful neglect), the Notice provides a correction procedure. As long as the employer has amended its plan on a timely basis, and the plan’s terms apply uniformly to all participants, the employer may avoid IRS penalties so long as the employer converts the excess contributions to taxable income reported as wages on the applicable W-2.
The mistake may occur, for example, if an employee of a controlled group entity switches employment to another entity which is a part of the same controlled group and makes a new election under the new entity’s FSA, which, when combined with his pre-tax election under the previous employer’s plan, exceeds $2,500 maximum. The $2,500 maximum is applicable to the combined election. If the employee changes employment and goes to work for a new unrelated employer, the $2,500 maximum will apply to each FSA separately.
6. FSA Maximums.
It is worth noting that the FSA maximum in future years will be indexed for inflation.
7. Short Plan Year.
Some employers with calendar year plans may consider implementing a short plan year (ending November 30, 2012, for example) to avoid the January 1, 2013 implementation of the maximum and pushing out the maximum limitation until December 1, 2013. However, current regulations will permit a short plan year only if it’s done for a valid business reason. The IRS Notice states explicitly that employers who adopt a short plan year just to extend the implementation of the $2,500 pre-tax maximum will violate cafeteria plan rules.
8. Bellwether on Use It or Lose It Provision.
The IRS Notice also requests comments on how the IRS should modify the use-it or lose-it rule. The IRS already has allowed for a 2-1/2 month grace period for new claims to reduce the risk of forfeitures and may be considering further liberalizations.
If you have questions about your specific employee benefits plan, please call us at 800-969-2522 or email us and we’ll be happy to answer them.