IRS Releases Notice 2012-40 Providing Guidance Concerning the $2,500 FSA Contribution Limit

The IRS has released Notice 2012-40 which provides guidance on the effective date of the $2,500 contribution limit to health flexible spending arrangements (FSAs) under IRS Code Section 125(i). The notice states that “taxable year” refers to the plan’s “plan year;” therefore, the rule will not affect any plans beginning prior to January 1, 2013, and fiscal plan years will not be impacted until the first plan year beginning on or after January 1, 2013.

This is good news for non-calendar year plans.  The guidance indicates plans will have until the end of the calendar year 2014 to amend their plans. The notice also provides relief for contributions that mistakenly exceed the $2,500 limit provided they are corrected in a timely manner.

Specifically, Notice 2012-40 provides the following:

• the $2,500 limit does not apply for plan years that begin before 2013;
• in the case of a short plan year, the $2,500 limit must be prorated based on the number of months in the short plan year;
• the $2,500 limit is applied on an employee by employee basis and is applied separately for each unrelated employer that an individual may be working for during the year;
• the term “taxable year” in § 125(i) refers to the plan year of the cafeteria plan as this is the period for which salary reduction elections are made;
• plans may adopt the required amendments to reflect the $2,500 limit at any time through the end of calendar year 2014;
• in the case of a plan providing a grace period (which may be up to two months and 15 days), unused salary reduction contributions to the health FSA for plan years beginning in 2012 or later that are carried over into the grace period for that plan year will not count against the $2,500 limit for the subsequent plan year;
• relief is provided for certain salary reduction contributions exceeding the $2,500 limit that are due to a reasonable mistake and not willful neglect and that are corrected by the employer., and
• the statutory $2,500 limit under § 125(i) applies only to salary reduction contributions under a health FSA, and does not apply to certain employer non-elective contributions (sometimes called flex credits).

In another very favorable development, the IRS is also calling for comments on modifying (and perhaps eliminating) the use-or-lose-it rule.