Time to Comply with $2,500 FSA Annual Contribtion Limit

The new limit applies to salary reduction contributions under a health care FSA

By Stephen Miller, CEBS June 6, 2012

last updated Nov. 18, 2013

Update: IRS Allows $500 Annual Carryover for Health FSAs

On Oct. 31, 2013, the U.S. Treasury Department and the IRS issued a notice and fact sheet announcing a major change to the long-standing use-or-lose rule for health flexible spending accounts (FSAs). The modification permits plans to allow participants to carry over $500 annually. Employers must amend their plans to eliminate the current grace period if they provide it. To learn more, see the SHRM Online report FSA Use-It-or-Lose-It Rule Modified.

The U.S. Internal Revenue Service issued Notice 2012-40 on May 30, 2012, with guidance on the $2,500 limit on pretax employee contributions to health care flexible spending accounts (FSAs) under the Patient Protection and Affordable Care Act (PPACA). The reform law limit on the amount that employees can set aside in FSAs is scheduled to take effect in 2013.

Among the points clarified in the notice:

  • The $2,500 limit is effective for plan years starting January 1, and not the taxpayer's tax year. Employers with fiscal year health care FSAs may keep higher reimbursement limits in effect through the end of their 2012-2013 plan year.
  • Employers may adopt retroactive amendments to impose the $2,500 limit before Dec. 31, 2014.
  • The $2,500 limit applies only to salary reduction contributions under a health care FSA and does does not limit the amount permitted for reimbursement under an FSA for dependent care assistance or adoption care assistance. Nor does it apply to salary reduction or any other contributions to a health savings account (HSA) or to amounts made available by an employer under a health reimbursement arrangement (HRA). See the SHRM Online article "For 2013, Higher Limits for HSA Contributions and Out-of Pocket Expenses for High-Deductible Plans."
  • The $2,500 limit also does not apply to employer nonelective contributions — sometimes called flex credits — nor to salary reduction contributions to a cafeteria plan that are used to pay an employee's share of health coverage premiums (or the corresponding employee share under a self-insured employer-sponsored health plan) — sometimes referred to as "premium conversion" salary reduction contributions.
  • 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 care 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 result from a reasonable mistake and not willful neglect and that are corrected by the employer.

'Use or Lose' Rule Debated

In light of the $2,500 limit, the Treasury Department and IRS are considering whether to modify the annual "use it or lose it" rule that has been the bane of FSA users. That rule generally prohibits a contribution under an FSA from being used in a subsequent plan year or period of coverage. Unused amounts in the FSA are forfeited, typically to the employer, at the end of the plan year, with an additional grace period that employers may incorporate into their plans.

The IRS requested comments on whether the proposed regulations should be modified to provide additional flexibility with respect to the operation of the use-or-lose rule for health care FSAs and, if so, how any such flexibility might be formulated and constrained. Comments are also requested on how any such modifications would interact with the $2,500 limit."

The comment deadline ended on Aug. 17, 2012.

[Update: On Oct. 31, 2013, the Treasury Department and IRS issued a notice and fact sheet announcing that employers that offer FSA programs that do not include a grace period will have the option of allowing participants to roll over up to $500 of unused funds at the end of the plan year. See the SHRM Online article "FSA Use-It-or-Lose-It Rule Modified"]

The Employers Council on Flexible Compensation (ECFC), a trade group, issued a statement saying it has "heard from employers that many employees elect not to participate in an FSA because they fear losing their hard earned dollars. We have also heard from policy makers who have expressed concern that the use it or lose it rule encourages FSA participants to spend their dollars on unnecessary services and items at the end of the year, which contributes to inefficient health care spending. Eliminating the use it or lose it rule, however, will do away with this perverse incentive for such behavior."

However, some employers contend that the forfeited amounts are needed to cover the cost of providing FSA administrative services without passing those expenses along to employees.

Legislation Would Allow OTC Reimbursements

In another FSA-related development, Congress is considering legislation that would reverse the PPACA's ban on using FSAs and other pretax accounts to pay for most over-the-counter (OTC) medications without a prescription.

Under the reform law, employees with health care FSAs, health savings accounts (HSAs), health reimbursement arrangements (HRAs) and Archer medical savings accounts (MSAs) must present a doctor's prescription or a letter of medical necessity from a physician in order to use an account-linked debit card or check to purchase most OTC medications, or they must submit a receipt listing an Rx number or a doctor's prescription plus a receipt detailing the purchase in order to be reimbursed. The law took effect on Jan. 1, 2011.

As a result, the cost of OTC medications and other OTC items—including aspirin, acid reflux medications, allergy medications and eye drops—no longer can be reimbursed through FSAs and other tax-preferred arrangements without a prescription.

Exceptions allowing reimbursement are permitted for insulin, testing materials, birth control, first-aid kits and other medical supplies. A listing of what is and isn't covered by the OTC restriction is provided in a fact sheet from WageWorks, an FSA services provider.

H.R. 5842, Restoring Access to Medication Act, sponsored by Rep. Lynn Jenkins, R-Ky., and introduced on May 18, 2012, has drawn support and opposition. According to an opposing statement by the Center on Budget and Policy Priorities: "Just one worker in seven has an FSA, and an even smaller fraction of workers is enrolled in other tax-favored accounts. High-income people benefit disproportionately from tax-advantaged accounts because they are in higher tax brackets, tend to consume more health care, and can afford to deposit larger amounts in their accounts. Purchases of over-the-counter medicines, such as aspirin and cough syrup, constitute routine personal expenses that do not generally deserve a tax subsidy."

However, the American Medical Association is among those advocating for an end to the OTC reimbursement exclusion. An AMA statement contends: "Rather than saving money, the new policy may increase overall health care spending by forcing patients to schedule office visits with their physicians to obtain prescriptions for OTC medications, or they may seek more expensive prescription drugs that are covered by their health insurance plans. Furthermore, since a prescription for an OTC product must be treated as any other prescription, recordkeeping requirements are increased for both physicians and pharmacies."

Stephen Miller, CEBS, is an online editor/manager for SHRM.

Related SHRM Articles:

Related External Article:

Working with the New Annual Limit on FSA Contributions, Verrill Dana LLP, November 2012

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