June 4, 2012  
IRS Issues Guidance Related to Cafeteria Plans (and Health FSA Dollar Limits) Under Healthcare Reform

The IRS issued Notice 2012-40 which clarifies some of the requirements under Healthcare Reform that restricts the annual limit for health flexible spending accounts (FSAs) to $2,500 in 2013 and provides additional guidance for Section 125 (cafeteria) plans.

How Does This Notice Impact Employers and Cafeteria Plans?
Notice 2012-40 (i) gives an explanation regarding the effective date of the upcoming health FSA limit, (ii) explains the importance of plan amendments for the new rule, (iii) provides some relief for contributions in excess of the $2,500 made in error, (iv) clarifies the impact that the dollar limit has on health FSAs with grace periods, and (v) provides other details with respect to how the limit will impact cafeteria plans.

Most notably, the Notice clarifies that the term “taxable year” under a cafeteria plan is not the employee’s tax year or the calendar year (January 1 – December 31) as earlier guidance suggested. Rather the term “taxable year” refers to the actual plan year of the cafeteria plan and represents the period for which elections are made and are effective. This guidance offers relief for cafeteria plans that operate on non-calendar plan years and confirms that non-calendar plan year health FSAs are not required to comply with the $2,500 limit as of January 1, 2013. (See prior eAlert regarding non-calendar year cafeteria plans and the dollar limit: eAlert). Instead, non-calendar year cafeteria plans that offer a health FSA will be required to comply with the health FSA limit as of the first plan year that begins after January 2013. For example, a cafeteria plan that operates on a 7/1 – 6/30 plan year will be required to comply with the $2,500 limit for their health FSAs as of 7/1/2013, not 1/1/2013.

In addition to the clarification regarding the effective date of the limit for non-calendar year cafeteria plans, Notice 2012-40 also provides the following:

  • Cafeteria plan years that begin before 2013 are not required to comply with the $2,500 annual health FSA limit until the beginning of the 2013 cafeteria plan year.
  • When a cafeteria plan provides a grace period, unused contributions from the 2012 plan year or later will not count against the $2,500 annual limit.
  • Relief is provided for employee contributions that exceed $2,500 due to a reasonable mistake (and not willful neglect) provided that the employer and the employer’s cafeteria plan meets certain requirements.
  • The limit of $2,500 for health FSAs do not apply to certain non-elective employer contributions (i.e., flex credits), other FSAs, health saving accounts (HSAs), or health reimbursement accounts (HRAs).
  • Cafeteria plans must be amended if the health FSA limit will change as a result of the statue.  Plans have until the end of 2014 to adopt the required amendment that reflects the $2,500 limit and this amendment may be made retroactively to the date the limit of $2,500 first became effective.  This is an exception to the general rule that cafeteria plan amendments must be prospective only.

It’s also important to note that Notice 2012-40 reinforces that a cafeteria plan must have a written document and the document must be amended to comply with the new limit requirements. The Notice confirms that a cafeteria plan’s failure to have a written plan document and/or its failure to comply with the new limit results in the plan not being a cafeteria plan “and the value of taxable benefits that an employee could have elected to receive under the plan during the plan year is includible in the employee’s gross income, regardless of the benefit elected by the employer.” (There may also be tax implications for employer pre-tax contributions if a cafeteria plan is found not to comply with the applicable rules.)

What Should Employers Do Next?

All employers that offer a cafeteria plan with a health FSA should take action to ensure their cafeteria plan complies with the applicable rules.

  • Employers that offer non-calendar year health FSA need not make plan changes or restrict the limit on their health FSA as of January 2013 solely for the purpose of complying with the limit requirements. Compliance with the limit restriction is not required until the first cafeteria plan year after January 1, 2013.
  • All employers that offer a cafeteria plan with a health FSA should take the proper steps to amend their cafeteria plan so the plan reflects the limit restriction.
  • Employers are urged to work with their health FSA vendor and/or payroll vendors to mitigate the potential for employees to make contributions over the limit of $2,500 for plan years after 2013.

If you have any additional questions regarding the information within this eCommunication, please call Corporate Synergies at 1.866.CSG.1719 or CLICK HERE to contact us today.

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