With all the new health care legislation passed this year, many are wondering how flexible spending accounts will be affected. According to AlanHaft.com, the new health care reform legislation impacts flexible FSAs in the way over-the-counter medications are handled and increases taxes on nonqualified distributions.
Beginning in 2011, FSAs cannot make reimbursements for the cost of over-the-counter medications, such as nonprescription pain relievers, cold medicines, antacids and allergy medications. However, insulin and over-the-counter medications prescribed by a physician will still be reimbursable on a tax-favored basis by these plans. You may want to stock up on your over-the-counter drugs to take advantage of the available reimbursement before the end of this year.
The IRS also resolved uncertainty involving the new over-the-counter restriction on what are known as "grace period" FSAs. Under rules the IRS issued in 2005, unused contributions made to FSAs in the current year can be rolled over to pay for expenses incurred during the first two and a half months in the following year. The new IRS rules say over-the-counter reimbursements are banned for grace-period FSAs and FSAs without grace periods effective January 1, 2011. Congress imposed the new limits to raise revenue to help pay for other provisions in the reform law that expand coverage, such as new federal insurance premium subsidies for 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 reimbursement for qualified medical expenses is limited to $2,500. This figure is adjusted for inflation in subsequent years, and the reduction does not apply to health FSAs that aren't part of a cafeteria plan.
And, to cap off the new FSA regulations, you need to know the fine print in the new law, according to Wolters Kluwer. Effective for tax years beginning after Dec. 31, 2012, a health FSA is not 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 is not qualified.
Under such circumstances, an employee is subject to tax on distributions from the health FSA, thereby, eliminating any of the tax benefits of health FSA contributions, including those under $2500. There is a silver lining to the new limitation in that it protects employees from large forfeitures and protects 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.
And there are state tax consequences. The limitation of FSA contributions to $2,500 for tax years after 2012 does 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 is rounded down to the next lowest multiple of $50.
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