Employer did retroactive discrimin testing on FSA plan. StatesnI was ineligible for DC FSA 2022 & will issue new w2. Ismthis appropriate and can I expect IRS penalty?

[cuglietto]

I have no issue with learning I am ineligible now a high wage earner but am concerned about submitting amended return about a restriction I was never informed about and they were delayed in conducting their testing. In addition staffing challenges in IRS has always led to long confusing road to resolution to any changes.

[Mike9241]

This seems to be a problem between your employer and you since it is it's responsible for doing timely antidiscrimination testing.   As a HCE your contributions would not be deductible so you will owe more taxes and penalties. file an amended return and pay the additional taxes. The IRS will send you a notice about penalties. The notice will contain instructions of how to get the penalties abated.

You may be given one of the following types of penalty relief depending on the penalty:

1) First Time Penalty Abate and Administrative Waiver
2) Reasonable Cause

see this link for how to request penalty relief

https://www.irs.gov/payments/penalty-relief#eligible 

if the IRS denies relief talk to your employer to see if they'll do anything to make you whole. If not, your only option would be to consult an attorney to see if your employer could be held liable but the costs would probably be prohibitive but you can always call to get an idea. 

[Opus 17]

When you amend the return, you will remove the DCFSA and the amount ($5000?) will be added back to your taxable income.  However, you should be eligible for a revised dependent care credit that will cover some of the  difference.  Since the credit is 20% of expenses and your income tax rate might be 22%, 24% or higher, the credit probably won't cover all the taxes on the added income.  After filing the amended tax return and paying the additional amount owed, you may get a bill for interest back-dated to the original due date of the return, April 18, 2023.  This is unavoidable and can't be waived.  (However, per Mike, you could make an argument that your employer should reimburse you for the interest.) If you owe more than $1000 in additional tax, the IRS could also include penalties for under-paying your taxes, also back-dated to April 18, 2023.  This penalty can be appealed for cause (and you have a very good cause).

You will also need to file an amended state tax return.

[Edited to add: You should probably expect to get a corrected W-2 from the employer.  Wait for that to file the amended return.]