2013 is fast
approaching and many employers must prepare for the new Medical FSA
limit of $2,500. While we know this health care reform change means
plans starting on January 1, 2013 and beyond must limit Medical FSA
contributions to $2,500, it's less clear how the limit affects plans
starting January 2, 2012 through December 31, 2012. It is our
understanding that the literal language of the rule states that a
plan year, for example, beginning February 2, 2012 must adhere to the
limit. However, there's some hope that the IRS may
"clarify" the rule and allow plans starting January 2, 2012
through December 31, 2012 to postpone using the new limit. That may
be wishful thinking, however. Below is a more complete explanation of
the current rule and the options to consider.
is the new rule effective?
The rule, which caps the
amount of elections made for a taxable year, is effective for taxable
years beginning after December 31, 2012. The taxable year is typically
a calendar. Alternatively, the rule applies to elections made for tax
years starting with the tax year beginning January 1, 2013.
The statute fails to reference the "plan year" of the
Health FSA, even though Health FSA elections are typically made for a
plan year. The failure to reference the term plan year creates
compliance and operational challenges for plan sponsors that maintain
Health FSAs with a fiscal plan year.
For Health FSAs that have a calendar plan year, applying the effective
date is relatively simple due to the plan year and the taxable year
being the same. However, the failure to reference the plan year
creates challenges for Health FSAs that have a fiscal plan year.
Thus, there are three
potential interpretations regarding how the rule is applied to Health
FSAs with fiscal years--each of which is addressed below (in no
To better illustrate the
application of each interpretation, we will use as our exemplar a Health
FSA sponsored by ABC Company with an April 1 through March 31 plan
The rule may impact any salary reductions made during the calendar
year, without regard to the plan year of the Health FSA or when the
election was made. Thus, ABC's compliance with the new rule would be
measured by looking at an employee's salary reductions made during
the last 3 months of the 2012 plan year (January, February and March
2013) and the employee's salary reductions for the first 9 months of the
2013 plan (April through December).
This interpretation would require that ABC either amend its plan
prior to the start of the 2012 plan year to cap all Health FSA salary
reductions made during the 2012 plan year at $2500 or amend the plan
prior to the start of the 2013 plan year and simply limit the salary
reduction amount for the 2013 plan year. This would ensure that the
sum of each employee's salary reductions in the last 3 months of the
2012 plan year (i.e. January, February, and March 2013) and the
salary reductions made by each employee during the first 9 months of
the 2013 plan year do not exceed $2500. While this seems like an
arduous task, it likely isn't, at least for plan sponsors whose
current FSA annual maximum isn't excessive.
The rule applies only to elections with an effective date in 2013,
without regard to the plan year. Unlike Interpretation #1, elections
with an effective date in 2012 would not be subject to the new cap,
even though such elections include a coverage period that extends
into 2013. But, those making an election with an effective date in
2013, even if for the 2012-13 plan year, would be subject to the
Under Interpretation #2, ABC would need to amend its plan prior to
January 1, 2013.
The rule first applies to plan years beginning on or after January 1,
2013. Thus, the rule would first apply to ABC's Health FSA on April
1, 2013 and no one making an election for the 2012 plan year, even if
the election included coverage months, or was first effective in
2013, would be subject to the cap.
interpretation provides the greatest amount of administrative
flexibility. For example, ABC would have to amend its plan prior to
April 2013-not before the 2012 plan year or January 1, 2013, as in
the first two interpretations-and employees making an election for
the 2012 plan year would not be subject to the cap, thereby delaying
application of the rule for ABC and other plan sponsors with fiscal
plan years. Unfortunately, this interpretation simply isn't
consistent with the literal language of the statute, which makes no
reference to the plan year on which this interpretation is
the next steps?
We expect the IRS to issue guidance in the near future that will
clarify the effective date of the rule-hopefully in a way that is
administratively convenient for plan sponsors and administrators.
However, in the absence of formal guidance from the IRS, plan
sponsors with fiscal plan years will need to make a decision
regarding the appropriate action to take. Ultra conservative plan
sponsors may feel compelled to adopt Interpretation #1 and amend
their plan prior to the beginning of the 2012 plan year so that all
2012 elections are subject to the $2500 cap. Others will decide to
take a wait and see approach and we don't necessarily disagree with
this. Even if the IRS formally adopts interpretation #1 after your
2012 fiscal plan year begins (i.e. the 2500 cap applies to salary
reductions made in 2013 without regard to the plan year), adjustments
can be made to the 2013 plan year elections to ensure compliance,
which gives plan sponsors some flexibility to take a wait and see
approach. Interpretations #2 and 3 have flexibility built into them
so there is no possible interpretation that absolutely requires you
to take action now.
new rule require a plan amendment?
Yes, the new rule requires a
plan amendment to the extent that your current Health FSA annual
salary reduction maximum is greater than $2500. Thus, if ABC's
maximum annual salary reduction election is $2000, no amendment is
Practice Pointer: Don't forget that plan amendments must be
"formally" adopted by the individual(s) authorized by the
company's governing documents to amend plans. Moreover, the formal
amendment must be completed prior to the effective date.
cap apply also to any non-elective employer contributions, such as
The literal language of the statute appears to impose a cap ONLY on
an employee's Health FSA salary reduction elections. Thus, absent a
contrary clarification from the IRS, an employer's non-elective
contributions to the Health FSA, such as matching contributions,
would not be subject to the cap.
Practice Pointer: If the cap
ultimately does not apply to employer's non-elective contributions,
the Health FSA reimbursement maximum could be higher than $2,500. For
example, an employer who establishes a $2500 cap on salary reductions
could also provide matching contributions to raise the maximum annual
reimbursement to $5,000.
new rule affect any other cafeteria plan salary reductions?
No, the amendments to Code
Section 125 made by Section 9005 of PPACA apply only to Health FSA
Alston & Bird LLP
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