Good News in IRS Guidance on the $2,500 Health FSA Limit


The IRS recently issued Notice 2012-40 providing guidance on the $2,500 limit on salary reduction contributions to health flexible spending arrangements (“health FSAs”) under cafeteria plans.  The $2,500 limit is a new requirement that was added by the Patient Protection and Affordable Care Act and many plan sponsors (especially those with non-calendar year plans) have had compliance questions.  The IRS Notice provides clarifications on several important points.

Limit Applies for Plan Years That Begin After December 31, 2012

The guidance specifies that the $2,500 limit applies on a plan year basis, not on an employer's or employee's taxable year basis, and is effective for plan years that begin after December 31, 2012.  This resolves an important issue for non‑calendar year cafeteria plans.  For example, a cafeteria plan with a plan year beginning on July 1, 2012 is not required to apply the $2,500 limit for the plan year that starts on that date.  Instead, the limit will first apply for the plan year that begins on July 1, 2013.

Limit Applies Only to Employee Salary Reductions Under Health FSAs

The guidance also clarifies that the $2,500 limit applies only to employee salary reduction contributions to health FSAs, not to employer non‑elective contributions (sometimes called flex credits) that cannot be cashed out.  For example, if an employer provides $1,000 in non-elective contributions that the employee may use for any qualified benefit offered under the cafeteria plan, but cannot be taken by the employee in cash, the $1,000 will not count against the $2,500 limit on the employee's salary reduction contributions.  On the other hand, if the employer's $1,000 contribution can be taken by the employee in cash, it will count against the limit.  In addition, the guidance clarifies that the limit does not apply to arrangements such as employee salary reduction contributions that are used to pay for the employee's share of health coverage premiums (sometimes referred to as premium conversion plans), contributions to health savings accounts or health reimbursement arrangements.

Grace Period Carryover Not Affected

The effect of a grace period on the $2,500 limit also raised questions that are resolved by the guidance.  If a cafeteria plan provides for a grace period under which employees may use amounts remaining in the health FSA from the previous plan year to pay for qualified expenses incurred during the grace period, unused amounts that are carried over to the grace period do not count against the $2,500 limit.

Plan Amendment Due December 31, 2014

The guidance also gives plan sponsors until December 31, 2014 to amend their cafeteria plans to set forth the $2,500 limit (or a lower limit chosen by the sponsor), provided the plan is operated in accordance with the limit for plan years beginning after December 31, 2012.

Per-Employee and Per-Employer Basis

The $2,500 limit applies on an employee-by-employee basis and an employer-by-employer basis.  For example, if two spouses are employed by the same employer and each spouse is eligible for the same cafeteria plan health FSA, each may contribute $2,500.  But the guidance also requires aggregation of health FSA contributions by all employers in the same controlled group or affiliated service group, because they are considered a single employer.  For example, an employee participating in two separate cafeteria plan health FSAs that are sponsored by two employers in the same controlled group may contribute a total of only $2,500 to the two health FSAs.  But if the two employers are not related, the employee may contribute $2,500 to each of the two health FSAs.

Excess Contribution Relief; Change to the Use-It-Or-Lose-It Rule

Finally, the Notice provides relief for erroneous excess contributions caused by the plan sponsor's reasonable mistake if certain requirements are met and requests comments regarding whether and how the "use-it-or-lose-it" rule should be modified.  A copy of the Notice is available at

Practical Tips

  • Employers should be careful to communicate to employees when and to what the $2,500 limit applies, so that employees will not be confused about other amounts that will not count against the limit, such as grace period carryovers, employer flex credits that cannot be cashed out, contributions to HSAs or HRAs, or employee salary reduction contributions to premium conversion plans.
  • Even though the guidance allows until December 31, 2014 for plan sponsors to adopt the required amendment, an earlier adoption could avoid misunderstandings by participants and prevent the amendment from slipping between the cracks.

  • Employers that are members of a controlled group of employers or an affiliated service group should review their administrative procedures to ensure that they will be able to identify any employees that are eligible under more than one health FSA sponsored by related employers and limit the employee salary reduction contributions accordingly.

© 2012 Perkins Coie LLP