The Affordable Care Act (ACA) imposes an annual $2,500 limit on the amount of salary reduction contributions that an employee may make to a health flexible spending account (Health FSA). This limit applies to tax years beginning after December 31, 2012, and is indexed for inflation in ensuing years. In a recently issued notice, the Internal Revenue Service provides guidance about different aspects of this limit, including the following:

  • The tax year is determined with reference to a Health FSA’s plan year. Often the plan year will be the calendar year, but for a Health FSA with, for example, a July 1–June 30 plan year, the limit will first apply to the plan year that begins July 1, 2013. Employers may not change a Health FSA’s plan year for the purpose of delaying application of the new limit.
  • The limit applies only to salary reduction contributions and only to Health FSAs. As a result, the limit affects only amounts contributed to a Health FSA that an employee could have elected to receive as cash.
  • The limit applies separately to each employee with respect to all Health FSAs maintained by a single employer. Closely related employers—like those in a controlled group of corporations or an affiliated service group—will be treated as a single employer for this purpose. Accordingly, the contributions made by one employee to two separate Health FSAs maintained by closely related employers must be aggregated to determine if the total exceeds $2,500. However, an employee and spouse may each contribute up to $2,500 to a Health FSA even if they work for the same employer and participate in the same Health FSA.
  • Where a Health FSA provides for a grace period, contributions that are carried over to pay expenses incurred in the following year do not count against the $2,500 limit in that following year.
  • The plan document of a Health FSA must be amended to reflect the limit on or before December 31, 2014. However, the Health FSA must operate in compliance with the limit from the date the limit takes effect.
  • The notice allows employers to correct contributions that exceed the $2,500 limit provided that: 1) the excess contributions arise from reasonable mistakes and not willful misconduct, 2) the Health FSA document is amended on time to reflect the limit, 3) the employer has not received a notice from the IRS specifically citing a violation of the limit, and 4) the employer’s cafeteria plan is not under audit by the IRS with respect to the year for which the mistake was made.

The notice also announces that the IRS is considering changes to its “use-it-or-lose-it” rule (beyond the availability of a grace period for incurring expenses) and solicits comments on potential modifications to that rule.

Controversy regarding this provision of the ACA may yet spur a legislative change to increase or eliminate the $2,500 limit. While it is possible that such action may take place before Health FSA documents need to be amended, the prospects that Congress will act before information systems and administrative processes need to be modified and before annual enrollment communications need to be prepared are dwindling.

As the federal health care reform effort gained steam, Ballard Spahr attorneys launched the Health Care Reform Initiative to monitor and analyze legislative developments. With federal health care reform now a reality, our attorneys are assisting health care entities and employers in understanding the relevant changes and planning for the future. If you have questions regarding the contents of this legal alert, contact Edward I. Leeds at 215.864.8419 or, or the Ballard Spahr attorney with whom you work.