The Internal Revenue Service (IRS) has raised the FSA limit (the cap on contributions to flexible spending accounts) used to pay for healthcare expenses to $2,650 for 2018.
A $2,500 FSA limit, which became effective on January 1, 2013, was included in the Patient Protection and Affordable Care Act of 2010 (PPACA). The U.S. Supreme Court reviewed the constitutionality of the PPACA and upheld the provision in a June 28, 2012, decision.
Under the tax law provisions covering “cafeteria plans,” an employee participating in an FSA can choose to allocate a portion of his or her salary to the account on a pre-tax basis, thereby reducing tax liability.
The employer also saves tax because the contributions aren’t subject to employment taxes. These tax savings can usually offset part or all of the employer’s administrative costs for the plan.
The most common type of FSA is used to pay for healthcare expenses. Another variation covers dependent care expenses.
Previously, a $5,000 FSA limit applied to dependent-care FSAs, but there was no tax law limit on health care FSAs (although employers might self-impose a limit). Under the PPACA, a $2,500 limit for healthcare expenses applied for tax years beginning after 2012.
The limit has been raised a couple times to account for inflation.
How a Healthcare FSA works
Typically, an employer allows employees to designate the amount to be contributed to the account at the beginning of the year. Then it deducts the amount from the paychecks of participating employers.
For example, if an employee allocates $2,400 to the FSA and he or she is paid semi-monthly, the payroll deduction is $100. Employees may tap into their accounts at any time to pay for qualified medical expenses.
However, any amount in the account that isn’t used by the end of year is forfeited. This “use-it-or-lose-it” feature of FSAs has often been criticized as being unfair.
Under a 2005 tax law change, an employer can make an election allowing a “grace period” of 2 1/2 months to give participants more time to empty out their accounts.
Conversely, qualified expenses are paid promptly, even if the account hasn’t been fully funded through payroll deductions. If a participant quits or retires before funding catches up, the employer is responsible for the excess. In addition, the employer may incur extra costs if it allows employees to change contribution levels due to a change in family status during the year.
A Few Details
- The term “tax year” refers to the cafeteria plan tax year, not the employer or employee’s tax year.
- A plan can’t change its tax year to delay application of the $2,650 limit.
- If a cafeteria plan has a short plan year, the limit must be pro-rated.
- The limit on salary contributions to a health FSA applies on an individual basis. Thus, a married couple may contribute up to $5,300.
- All employers in a controlled or affiliated service group are treated as a single employer for purposes of the limit.
- The limit doesn’t apply to reimbursements under an FSA for dependent care expenses.
- In the event the employer uses the optional 2 1/2 month grace period, any amount carried over into the next year won’t count against the limit for the subsequent year.