Commentators Want IRS To Lose FSA “Use It Or Lose It” Rule, Treasury Official Says


Treasury attorney-advisor Kevin Knopf reported October 12 that members of the public responding to Notice 2012-40 regarding health flexible spending accounts (FSAs) have requested that the government eliminate the “use it or lose it” rule. The rule requires FSA participants to use up their entire account balance for the calendar year, or lose any balance that remains.

Knopf, from the Treasury’s Office of Benefits Tax Counsel, and Stephen Tackney, IRS deputy associate chief counsel (Employee Benefits), Tax Exempt and Government Entities Division, provided an update on some of the IRS guidance issued under the Patient Protection and Affordable Care Act (ACA). They spoke at a conference sponsored by the American Bar Association’s Joint Committee on Employee Benefits about health and welfare benefit plans. Tackney indicated they were expressing their own personal views.

The ACA imposed an annual $2,500 limit on employee contributions to health FSAs. Previously, there was no statutory cap on employee contributions, although employers usually imposed a cap. Knopf said that the Treasury is looking at the interaction of the $2,500 limit and the “use or lose” rule and is considering whether to change it. “Time will tell,” Knopf said. However, for 2012, the “use or lose” rule still applies; any changes to the rule would not affect 2012, he said.

Notice 2012-40 indicated that the $2,500 cap will apply to cafeteria plan years beginning on or after Jan. 1, 2013, Knopf said. Thus, it does not apply to plan years starting before Jan. 1, 2013, even if the plan year extends into 2013. Although the effective date is 2013, plans do not have to be amended until the end of 2014 to provide for the cap, he stated.

Knopf noted that some employers anticipated that the cap would apply in 2012 and decided to limit employee contributions. Now that the cap does not apply for 2012, employers want to give employees a midyear election to increase their contributions. Knopf said that employees cannot change their election unless they have a “life event,” and that the issuance of IRS guidance is not a suitable event. He indicated that this policy is unlikely to change.

Nondiscrimination rules. In Notice 2011-1, the IRS adopted a nonenforcement policy regarding the nondiscrimination rules that apply to cafeteria plans. Knopf said this is still the policy, and that when the IRS issues rules, it will give employers enough time to phase in their application. He said not to anticipate guidance on this issue until guidance is issued under Code Sec. 4980H regarding the employer shared responsibility payment.

Tackney said that if the IRS does not issue guidance by the end of June, it generally will not apply the rules in the following year. Under this policy, taxpayers have at least six months advance notice, he said.

Employers are asking the government about the interaction of health reimbursement accounts (HRAs) and health FSAs, Knopf said. There are lots of issues, but the answers are not clear. Knopf said that the government is reluctant to treat HRAs as excepted benefits; this could lead to mischief at different levels of HRAs.

Form W-2 reporting. Carol Weiser of Sutherland Asbill & Brennan LLP, who moderated the panel, asked about Form W-2 reporting of health care benefits. The IRS provided guidance in Notice 2012-9. The IRS said that small employers, who furnish fewer than 250 Forms W-2 to their employees, do not have to report. Weiser asked whether related employers are aggregated for this requirement. According to an audience member, the IRS has stated that employers are not aggregated. Thus, if one employer provides 150 Form W-2s, and a related employer provides 125 Form W-2s, both are small employers that are exempt from reporting under the guidance.

MLR rebates. Tackney said that medical loss ratio rebates could be taxable to employee recipients, but it depends on the facts. Generally, if the individual’s health insurance contributions were after-tax, the rebates would not be taxable. If they were pre-tax, they would be taxable. If the rebate flows through a cafeteria plan on the participant’s behalf, there would be automatic adjustments, Tackney said; there would be less salary reduction, and more taxable salary.

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