The Internal Revenue Service has released guidance on the effective date of the $2,500 limit, as indexed for inflation, on salary reduction contributions to flexible spending arrangements for health expenses.

Notice 2012-40 provides guidance on the effective date of the $2,500 limit on health FSAs under Section 125(i) of the Tax Code and on the deadline for amending plans to comply with that limit. This notice also provides relief for certain contributions that mistakenly exceed the $2,500 limit and that are corrected in a timely manner. Finally, the notice requests comments on whether to modify the use-or-lose rule that is currently detailed in the proposed regulations with respect to health FSAs.

Specifically, the IRS notice provides that the $2,500 limit does not apply for plan years that begin before 2013; and the term “taxable year” in Section 125(i) refers to the plan year of the cafeteria plan as this is the period for which salary reduction elections are made. In addition, the IRS noted that plans may adopt the required amendments to reflect the $2,500 limit at any time through the end of calendar year 2014.

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 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.

The IRS is also providing relief for certain salary reduction contributions exceeding the $2,500 limit that are due to a reasonable mistake and not willful neglect and that are corrected by the employer.

The statutory $2,500 limit under Section 125(i) applies only to salary reduction contributions under a health FSA, and does not apply to certain employer non-elective contributions (sometimes called flex credits), to any types of contributions or amounts available for reimbursement under other types of FSAs, health savings accounts, or health reimbursement arrangements, or to salary reduction contributions to cafeteria plans 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).

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