Limitation On Health FSAs Offered in Cafeteria Plans

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So what’s included in Sec. 9005 of the Affordable Care Act, concerning the limitations placed on health flexible spending arrangements (FSAs) offered in cafeteria plans?

Effective for tax years beginning after Dec. 31, 2012, a health FSA will not be a qualified benefit under a cafeteria plan unless the plan provides for a $2,500 maximum annual salary reduction contribution to the FSA. If the plan does not specifically prohibit salary reductions in excess of $2,500, the benefit under the health FSA will not be qualified. Under such circumstances, an employee will be subject to tax on distributions from the health FSA, thereby eliminating any of the tax benefits of health FSA contributions, including those under $2500.

According to John Garner, a Principal with Garner Consulting of Pasadena, California and author of the Health Insurance Answer Book, there is a silver lining to the new limitation in that it will protect employees from large forfeitures and protect employers from employees who game the system by signing up for large amounts, submitting large claims early in the year and then terminating employment, leaving the employer stuck with the bill.

State Tax Consequences. The limitation of FSA contributions to $2,500 for tax years after 2012 will not impact states that conform to the federal exclusion by the time the provision takes effect. Because most states start their tax calculations with federal adjustable gross income, there should be no impact on those states. States that do not conform may allow an exclusion from taxation for amounts above the federal limitation as well.

Effective for tax years beginning after December 31, 2013, the $2,500 limitation is adjusted annually for inflation. Any inflation adjustment that is not a multiple of $50 will be rounded down to the next lowest multiple of $50.

Effective date. The amendments apply to tax years beginning after Dec. 31, 2012.

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