Effective Jan. 1, 2013, health care reform imposes a new $2,500 limit on annual contributions to a health care flexible spending arrangement (“Health FSA”). However, it is unclear whether the $2,500 limit applies on a plan year or calendar year basis. This creates potential compliance issues beginning in 2012 for non-calendar year cafeteria plans. 

For example, say an employer has a cafeteria plan year that runs from July 1 through June 30, and a participant elects to defer $6,000 for the 2012/2013 plan year, with monthly salary reductions of $500. The employee also elects to defer $2,500 for the 2013/2014 plan year, with monthly salary reductions of $208.33. If the $2,500 limit is applied on a calendar year, and not on a plan year, basis, the participant would exceed the $2,500 limit in 2013, as follows:

 Months  Salary Reductions in 2013
 January - June (2012/2013 plan year)     $3,000 ($500 x 6 months)
 July - December (2013/2014 plan year)     $1,250 ($208.33 x 6 months)

In the absence of IRS guidance, the plan administrator in this example may be required to prohibit future deferrals in 2013 after the participant reaches the $2,500 limit in May ($500 multiplied by five months of deferrals). Failure to comply with the limit could result in loss of tax qualified status for the plan, resulting in taxation of all benefits. In addition, it is also unclear how the limit may apply in future years, and whether it would be lifted automatically on Jan. 1, 2014, regardless of any family status changes.

Industry groups have requested transition relief and clarification given the uncertainty. At this point, there are potentially a number of different approaches. The simple approach is to limit each Health FSA participant to a maximum contribution of $2,500 for the plan year beginning in 2012. This requires a plan amendment before the beginning of the 2012/2013 plan year.

We expect the IRS to issue guidance shortly, which may permit a number of different approaches. In the meantime, if you have any questions or would like to discuss plan amendments, please call any member of the Davis Wright Tremaine Employee Benefits group.