With all the new health care legislation passed this year, manyare wondering how flexible spending accounts will be affected. According toAlanHaft.com, the new health care reform legislationimpacts flexible FSAs in the way over-the-counter medications arehandled and increases taxes on nonqualified distributions.

Beginning in 2011, FSAs cannot make reimbursements for the costof over-the-counter medications, such as nonprescription painrelievers, cold medicines, antacids and allergy medications.However, insulin and over-the-counter medications prescribed by aphysician will still be reimbursable on a tax-favored basis bythese plans. You may want to stock up on your over-the-counterdrugs to take advantage of the available reimbursement before theend of this year.

The IRS also resolved uncertainty involving the newover-the-counter restriction on what are known as "grace period"FSAs. Under rules the IRS issued in 2005, unused contributions madeto FSAs in the current year can be rolled over to pay for expensesincurred during the first two and a half months in the followingyear. The new IRS rules say over-the-counter reimbursements arebanned for grace-period FSAs and FSAs without grace periodseffective January 1, 2011. Congress imposed the new limits to raiserevenue to help pay for other provisions in the reform law thatexpand coverage, such as new federal insurance premium subsidiesfor the lower-income uninsured, beginning in 2014.

If you participate in an FSA as part of a cafeteria plan,beginning in 2013, the annual amount available for reimbursementfor qualified medical expenses is limited to $2,500. This figure isadjusted for inflation in subsequent years, and the reduction doesnot apply to health FSAs that aren't part of a cafeteria plan.

And, to cap off the new FSA regulations, you need to know thefine print in the new law, according to Wolters Kluwer. Effectivefor tax years beginning after Dec. 31, 2012, a health FSA is not aqualified benefit under a cafeteria plan, unless the plan providesfor a $2,500 maximum annual salary reduction contribution to theFSA. If the plan does not specifically prohibit salary reductionsin excess of $2,500, the benefit under the health FSA is notqualified.

Under such circumstances, an employee is subject to tax ondistributions from the health FSA, thereby, eliminatingany of the tax benefits of health FSA contributions,including those under $2500. There is a silver lining to the newlimitation in that it protects employees from large forfeitures andprotects employers from employees who game the system by signing upfor large amounts, submitting large claims early in the year andthen terminating employment, leaving the employer stuck with thebill.

And there are state tax consequences. The limitation ofFSA contributions to $2,500 for tax years after 2012 does notimpact states that conform to the federal exclusion by the time theprovision takes effect. Because most states start their taxcalculations with federal adjustable gross income, there should beno impact on those states. States that do not conform may allow anexclusion 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. Anyinflation adjustment that is not a multiple of $50 is rounded downto the next lowest multiple of $50.