Today, the Internal Revenue Service issued interim guidance to employers on informational reporting on each employee's annual Form W-2 of the cost of the health insurance coverage they sponsor for employees. The IRS is also requesting comments on this interim guidance. The IRS emphasized that this new reporting to employees is for their information only, to inform them of the cost of their health coverage, and does not cause excludable employer-provided health coverage to become taxable; employer-provided health coverage continues to be excludable from an employee's income, and is not taxable.

Reporting is Voluntary for All Employers for 2011 and Small Employers for 2012

The Affordable Care Act provides that employers are required to report the cost of employer-provided health care coverage on the Form W-2. Notice 2010-69, issued last fall, made this requirement optional for all employers for the 2011 Forms W-2 (generally furnished to employees in January 2012). In yesterday's guidance, the IRS provided further relief for smaller employers (those filing fewer than 250 W-2 forms) by making this requirement optional for them at least for 2012 (i.e., for 2012 Forms W-2 that generally would be furnished to employees in January 2013) and continuing this optional treatment for smaller employers until further guidance is issued.

Using a question-and-answer format, Notice 2011-28 also provides guidance for employers that are subject to this requirement for the 2012 Forms W-2 and those that choose to voluntarily comply with it for either 2011 or 2012. The notice includes information on how to report, what coverage to include and how to determine the cost of the coverage.

The 2011 Form W-2, prior IRS Notice 2010-69 deferring the reporting requirement for 2011, and Notice 2011-28 containing the new guidance are available on IRS.gov.

Under the proposed "Medical Flexible Spending Account Improvement Act" (H.R. 1004) co-sponsored by U.S. Reps. Charles Boustany (R-La.) and John Larson (D-Conn.), FSA participants would be allowed to withdraw and pay taxes on any remaining account balances rather than forfeit those funds to their employer.

Currently, the Code Section 125 regulations allow employers to use forfeited contributions to pay plan administrative expenses and offset costs incurred by employees who spend their FSA funds and then terminate employment.

Most Health Benefit Advisers would prefer legislation to allow unused FSA dollars to simply remain in an individual's FSA to meet future health care needs. That way the funds could continue to be available for the purpose they were intended to serve and both employees and employers could be spared the need to pay taxes on excess FSA contributions.

Many employer clients reported that the rule discouraged participation in "cafeteria plans" as these FSA plans are commonly called. These plans are an important employee benefit as employee contributions to premiums and other out-of-pocket expenses increase. FSAs can help families save by using pre-tax dollars to pay for theses expenses. The use-it-or-lose-it rule is a missed opportunity for FSA participants to better manage their health. This legislation ensures that individuals will not be forced to use up or forfeit any remaining FSA funds simply because their families' needs did not match their predicted annual health care expenses

The rule was designed to prevent FSAs from being turned into tax shelters during a time when that concern was top of mind at the federal level, but in 2013 the Patient Protection and Affordable Care Act will slice in half the $5,000 maximum FSA contribution that each employee is now allowed to make. FSA proponents argue that the impending change will eliminate such concerns.

Reps. Boustany and Larson recently noted in a letter that more than 85% of large employers offer FSAs, but only 20% to 22 % of eligible employees enroll. The principal reason for not enrolling, or for underfunding accounts is fear of the use-or-lose provision. They also said that one quarter of participants forfeit some of their FSA funds each year.