Flexible spending account
Encyclopedia
A flexible spending account (FSA), also known as a flexible spending arrangement, is one of a number of tax-advantaged financial accounts that can be set up through a cafeteria plan
of an employer in the United States
. An FSA allows an employee to set aside a portion of earnings to pay for qualified expenses as established in the cafeteria plan, most commonly for medical expenses but often for dependent care or other expenses. Money deducted from an employee's pay into an FSA is not subject to payroll tax
es, resulting in substantial payroll tax savings. One significant disadvantage to using an FSA is that funds not used by the end of the plan year are lost to the employee.
The most common type of flexible spending account, the medical expense FSA (also medical FSA or health FSA), is similar to a health savings account
(HSA) or a health reimbursement account
(HRA). However, while HSAs and HRAs are almost exclusively used as components of a consumer driven health care
plan, medical FSAs are commonly offered with more traditional health plans as well. In addition, funds in a health savings account
are not lost when the plan year is over, unlike funds in an FSA. Paper forms or an FSA debit card
, also known as a Flexcard, may be used to access the account funds.
Prior to the enactment of the Patient Protection and Affordable Care Act
, the Internal Revenue Service permitted employers to enact any maximum annual election for their employees. Patient Protection and Affordable Care Act
amended Section 125 such that FSAs may not allow employees to choose an annual election in excess of $2,500. Employers have the option to limit their employees' annual elections further. This change starts in tax years that begin after December 31, 2012.
Some employers choose to issue a debit card to their employees who participate in the FSA. Participants may use the debit card to pay for their FSA-eligible expenses at the point of sale. Pharmacies and grocery stores who choose to accept the debit card as payment must disallow transactions at point of sale if the participant attempts to pay for items that are not eligible under an FSA. In addition, employers still must require employees to provide itemized receipts for all expenses charged to the debit card. The IRS allows employers to waive this requirement when an individual uses the debit card at a pharmacy or grocery store that complies with the above procedure. The IRS also allows employers to waive this requirement when the amount charged to the debit card is a multiple of a co-pay of the employee's group health insurance plan. In most cases, the FSA administering firm will prefer actual insurance Explanations of Benefits (EOBs) clearly representing the patient portion of any medical expense, over other, more vague documentation. This requirement is becoming less cumbersome as more insurances allow patients to search for past EOBs on their websites.
dependents who live with the person, such as parents or grandparents. Additionally, the person or persons on whom the dependent care funds are spent must be able to be claimed as a dependent on the employee's federal tax return. The funds cannot be used for summer camps (other than "day camps") or for long term care for parents who live elsewhere (such as in a nursing home).
The dependent care FSA is federally capped at $5,000 per year, per household. Married spouses can each elect an FSA, but their total combined elections cannot exceed $5,000. At tax time, all withdrawals in excess of $5,000 are taxed.
Unlike medical FSAs, dependent care FSAs are not "pre-funded"; employees cannot receive reimbursement for the full amount of the annual contribution on day one. Employees can only be reimbursed up to the amount they have had deducted during that plan year.
While medical FSAs almost always favor the taxpayer, dependent care FSAs are a more complicated matter because they are a tradeoff between pre-tax deductions and tax credits, not itemized deduction
s. Enhancements to Child and Dependent Care Credit
s in recent years have made them more attractive than dependent care FSAs for some taxpayers, particularly those having more than one dependent in care or with adjusted gross incomes below $35k.
If married, both spouses must earn income for the Dependent Care FSA to work. The only exception is if the non-earning spouse is disabled or a full-time student. If one spouse earns less than $5,000 then the benefit is limited to whatever that spouse earned. Many plan coordinators do not warn of this limit. This limitation can create a situation where the earning spouse sets up a Dependent Care FSA and dutifully sends in receipts to withdraw funds and then at tax time the FSA is effectively eliminated and all the work wasted. See IRS Form 2441 Part III for details.
assistance through an FSA.
Also, one cannot have a health care FSA if he or she has a High Deductible Health Plan (HDHP) with a Health Savings Account (HSA). In cases where an employee has a HDHP with a HSA, they are eligible for a Limited Expense FSA (LEX) (also called Limited Purpose FSA). These FSAs may be used to reimburse dental and vision expenses, regardless of any plan deductible; at the employers discretion, eligible medical expenses incurred after the deductible is met may also be reimbursable.
This means that if, for example, a person is employed by a company from January through June and covered on their cafeteria benefits plan (including FSA) during that time, but does not elect and pay for continued coverage under that plan (i.e., COBRA
), the person's coverage period is defined only as January through June, not January through December as one might think. In this example, all covered expenses must be incurred between January and June of that year.
was developed to eliminate "double-dipping," by allowing employees to access the FSA directly. It also simplified the substantiation requirement, which required labor-intensive claims processing. The debit card also enhances the effect of "pre-funding" medical FSAs. However, the substantiation requirement itself did not go away, and has even been expanded on by the IRS for the debit-card environment; therefore, withdrawal issues still remain for FSAs.
According to Celent, as of May 2006, there were approximately 6 million debit cards in the market tied to an FSA account, representing 25% of the FSA participating community. Celent projects that FSA cards will increase FSA adoption rates. The average card participation rate was around 20% as of May 2006. By 2010, it is projected this rate will increase to 85%.
authorized an optional 2½ month grace period
that employers can use in their plans, allowing use of the funds for 2½ months after the end of the plan year.
during the first period, the entire amount of the annual contribution can be claimed against the FSA benefits. If the employee is terminated, quits, or is unable to return to work, he does not have to repay the money to the employer.
The employee contributes to the FSA in small increments throughout the year (for example, 1/26 of the annual amount if one is paid every 2 weeks), but taken together, all employees of a company contribute the full average amount during any given period, and no real risk is incurred by the employer. In addition, instead of paying payroll taxes to the government, the employer typically pays only a small administrative fee to the plan of $4–10 per participating employee. This is much less than the employer would have paid for its share of payroll taxes. In addition, any money that is not used by the end of the plan year (or grace period) is returned to the employer. This is estimated to be up to 14% of the total employee contributions, which can be a substantial boon to the employer's bottom line.
If a company plans to lay off some employees, and announces such plans, then if multiple employees use their entire flexible benefit before they are terminated, that may cause the company to have to reimburse the plan. Typically, however, employers do not announce layoffs for specific employees with enough notice for employees to use the available benefits, and employees may actually lose their contributions in addition to being laid off.
An employee does not continue to contribute to the plan upon termination of employment. Thus, one could use the entire amount on day one of the plan year, terminate employment on day two of the plan year, and contributions would have been none or negligible (e.g., perhaps 1/26 in the case of biweekly contributions). The "free" money is not taxable. The reason for this is that the IRS views these plans as health insurance plans for tax purposes. According to IRS section 125, benefits received from a health insurance plan are not considered taxable income.
The same reasons that make pre-funding a possible benefit to an employee participating in a plan make them a potential risk to employers setting up a plan. The employer has to make up the difference that the employee has spent from the flexible spending account but not yet contributed if other employees' contributions do not account for the money spent. The amount the employer loses due to pre-funding may eventually be partially, totally, or more than made up by employees that do not spend all of the money in their FSA account by the end of the plan year and grace period (see above).
(OTC) drugs and medical items. In addition to substantially expanding the range of "FSA-eligible" purchases, adding OTC items made it easier to "spend down" medical FSAs at year-end to avoid the dreaded "use it or lose it" rule.
However, substantiation has again become an issue; generally, OTC purchases require either manual claims or, for FSA debit card
s, submission of receipts after the fact. Most FSA providers require that receipts show the complete name of the item; the abbreviations on many store receipts are incomprehensible to many claims offices. Also, some of the IRS rules on what is and isn't eligible have proven rather arcane in practice. The recently-developed inventory information approval system
(IIAS), separates eligible and ineligible items at the point-of-sale and provides for automatic debit-card substantiation.
However, drugs will have to have been prescribed to be reimbursable as of January 1, 2011 according to section 9003(f) of the Patient Protection and Affordable Care Act
.
Any money left unspent at the end of the coverage period is forfeited and can be applied to future plan administrative costs or can be equally allocated as taxable income among all plan participants; this is commonly known as the "use it or lose it" rule. Under most plans, the "coverage period" generally ceases upon termination of employment whether initiated by the employee or the employer, unless the employee continues coverage with the company under COBRA or other arrangement. An unfortunate possibility, especially in the case of unexpected, immediate layoff, is that should an employee have unused contributions in an FSA and no additional qualifying claims during the coverage period the employee will have the added insult of "losing" these funds. On the other hand, if the payroll taxes saved on the employee's contributions exceeds the amount the employee forfeited, then the employee has still saved money overall.
A second requirement is that all applications for refunds must be made by a date defined by the plan. If funds are forfeited, this does not eliminate the requirement to pay taxes on these funds if such taxes are required. For example, if a single person elects to withhold $5,000 for child care expenses and gets married to a non-working spouse, the $5,000 would become taxable. If this person did not submit claims by the required date, the $5,000 would be forfeited but taxes would still be owed on the amount.
Also, the annual contribution amount must remain the same throughout the year unless certain qualifying events occur, such as the birth of a child or death of a spouse.
Starting in 2011, some FSA participants, depending on their plan, will no longer be able to receive reimbursements from an FSA for over-the-counter drugs and medicines without a doctor's prescription.
Cafeteria plan
A cafeteria plan is a type of employee benefit plan offered in the United States pursuant to Section 125 of the Internal Revenue Code. Its name comes from the earliest such plans that allowed employees to choose between different types of benefits, similar to the ability of a customer to choose...
of an employer in the United States
United States
The United States of America is a federal constitutional republic comprising fifty states and a federal district...
. An FSA allows an employee to set aside a portion of earnings to pay for qualified expenses as established in the cafeteria plan, most commonly for medical expenses but often for dependent care or other expenses. Money deducted from an employee's pay into an FSA is not subject to payroll tax
Payroll tax
Payroll tax generally refers to two different kinds of similar taxes. The first kind is a tax that employers are required to withhold from employees' wages, also known as withholding tax, pay-as-you-earn tax , or pay-as-you-go tax...
es, resulting in substantial payroll tax savings. One significant disadvantage to using an FSA is that funds not used by the end of the plan year are lost to the employee.
The most common type of flexible spending account, the medical expense FSA (also medical FSA or health FSA), is similar to a health savings account
Health savings account
A health savings account is a tax-advantaged medical savings account available to taxpayers in the United States who are enrolled in a high-deductible health plan . The funds contributed to an account are not subject to federal income tax at the time of deposit. Unlike a flexible spending account...
(HSA) or a health reimbursement account
Health Reimbursement Account
Health Reimbursement Accounts or Health Reimbursement Arrangements are Internal Revenue Service -sanctioned programs that allow an employer to set aside funds to reimburse medical expenses paid by participating employees...
(HRA). However, while HSAs and HRAs are almost exclusively used as components of a consumer driven health care
Consumer driven health care
Defined narrowly, consumer-driven health care refers to third tier health insurance plans that allow members to use personal health savings accounts , Health Reimbursement Accounts , or similar medical payment products to pay routine health care expenses directly, while a high-deductible health...
plan, medical FSAs are commonly offered with more traditional health plans as well. In addition, funds in a health savings account
Health savings account
A health savings account is a tax-advantaged medical savings account available to taxpayers in the United States who are enrolled in a high-deductible health plan . The funds contributed to an account are not subject to federal income tax at the time of deposit. Unlike a flexible spending account...
are not lost when the plan year is over, unlike funds in an FSA. Paper forms or an FSA debit card
FSA debit card
An FSA Debit Card is a special type of debit card issued in the United States to access tax-favored spending accounts such as flexible spending accounts and health reimbursement accounts , and sometimes health savings accounts as well. All such cards to date bear the Visa, MasterCard, or...
, also known as a Flexcard, may be used to access the account funds.
Types
Most cafeteria plans offer two different flexible spending accounts; one is for qualified medical expenses and the other is for dependent care expenses. A few cafeteria plans offer other types of FSAs, especially if the employer also offers an HSA. Participation in one type of FSA does not affect participation in another type of FSA, but funds cannot be transferred from one FSA to another.Medical expense FSA
The most common type of FSA is used to pay for medical expenses not paid for by insurance, usually deductibles, copayments, and coinsurance for the employee's health plan. Other items eligible for reimbursement include such over-the-counter (OTC) items such as bandages, rubbing alcohol, first aid kits, and other medical expenses not distinguished as a drug or medicine. Prior to January 1, 2011, OTC medications were also reimbursable under health care FSA plans; however, the Patient Protection and Affordable Care Act changed the rules regarding these OTC expenditures, allowing reimbursement for these items only when purchased with a doctor's prescription, with the exception of insulin. Generally, allowable items are the same as those allowable for the medical tax deduction, as outlined in IRS publication 502.Prior to the enactment of the Patient Protection and Affordable Care Act
Patient Protection and Affordable Care Act
The Patient Protection and Affordable Care Act is a United States federal statute signed into law by President Barack Obama on March 23, 2010. The law is the principal health care reform legislation of the 111th United States Congress...
, the Internal Revenue Service permitted employers to enact any maximum annual election for their employees. Patient Protection and Affordable Care Act
Patient Protection and Affordable Care Act
The Patient Protection and Affordable Care Act is a United States federal statute signed into law by President Barack Obama on March 23, 2010. The law is the principal health care reform legislation of the 111th United States Congress...
amended Section 125 such that FSAs may not allow employees to choose an annual election in excess of $2,500. Employers have the option to limit their employees' annual elections further. This change starts in tax years that begin after December 31, 2012.
Some employers choose to issue a debit card to their employees who participate in the FSA. Participants may use the debit card to pay for their FSA-eligible expenses at the point of sale. Pharmacies and grocery stores who choose to accept the debit card as payment must disallow transactions at point of sale if the participant attempts to pay for items that are not eligible under an FSA. In addition, employers still must require employees to provide itemized receipts for all expenses charged to the debit card. The IRS allows employers to waive this requirement when an individual uses the debit card at a pharmacy or grocery store that complies with the above procedure. The IRS also allows employers to waive this requirement when the amount charged to the debit card is a multiple of a co-pay of the employee's group health insurance plan. In most cases, the FSA administering firm will prefer actual insurance Explanations of Benefits (EOBs) clearly representing the patient portion of any medical expense, over other, more vague documentation. This requirement is becoming less cumbersome as more insurances allow patients to search for past EOBs on their websites.
Dependent care FSA
FSAs can also be established to pay for certain expenses to care for dependents who live with someone while that person is at work. While this most commonly means child care, for children under the age of 13, it can also be used for children of any age who are physically or mentally incapable of self-care, as well as adult day care for senior citizenSenior citizen
Senior citizen is a common polite designation for an elderly person in both UK and US English, and it implies or means that the person is retired. This in turn implies or in fact means that the person is over the retirement age, which varies according to country. Synonyms include pensioner in UK...
dependents who live with the person, such as parents or grandparents. Additionally, the person or persons on whom the dependent care funds are spent must be able to be claimed as a dependent on the employee's federal tax return. The funds cannot be used for summer camps (other than "day camps") or for long term care for parents who live elsewhere (such as in a nursing home).
The dependent care FSA is federally capped at $5,000 per year, per household. Married spouses can each elect an FSA, but their total combined elections cannot exceed $5,000. At tax time, all withdrawals in excess of $5,000 are taxed.
Unlike medical FSAs, dependent care FSAs are not "pre-funded"; employees cannot receive reimbursement for the full amount of the annual contribution on day one. Employees can only be reimbursed up to the amount they have had deducted during that plan year.
While medical FSAs almost always favor the taxpayer, dependent care FSAs are a more complicated matter because they are a tradeoff between pre-tax deductions and tax credits, not itemized deduction
Itemized deduction
An itemized deduction is an eligible expense that individual taxpayers in the United States can report on their federal income tax returns in order to decrease their taxable income....
s. Enhancements to Child and Dependent Care Credit
Child and Dependent Care Credit
The Household and Dependent Care Credit is a nonrefundable tax credit available to United States taxpayers. Taxpayers that care for a qualifying individual are eligible. The purpose of the credit is to allow the taxpayer to be gainfully employed. This credit is created by 26 U.S.C...
s in recent years have made them more attractive than dependent care FSAs for some taxpayers, particularly those having more than one dependent in care or with adjusted gross incomes below $35k.
If married, both spouses must earn income for the Dependent Care FSA to work. The only exception is if the non-earning spouse is disabled or a full-time student. If one spouse earns less than $5,000 then the benefit is limited to whatever that spouse earned. Many plan coordinators do not warn of this limit. This limitation can create a situation where the earning spouse sets up a Dependent Care FSA and dutifully sends in receipts to withdraw funds and then at tax time the FSA is effectively eliminated and all the work wasted. See IRS Form 2441 Part III for details.
Other FSAs
There are FSA plans for non-employer sponsored premium reimbursement and parking and transit expense reimbursement. The individual premium account allows an employee to pay for his or her spouse’s insurance with pre-tax dollars as long as the other coverage is a non-employer-sponsored, is considered an individual plan, and is directly billed to the member or the member’s spouse. A parking and transit account allows employees to pay parking or public transit expenses with pre-tax dollars up to certain limits. Though not as common as the FSAs listed above, some employers have offered adoptionAdoption
Adoption is a process whereby a person assumes the parenting for another and, in so doing, permanently transfers all rights and responsibilities from the original parent or parents...
assistance through an FSA.
Also, one cannot have a health care FSA if he or she has a High Deductible Health Plan (HDHP) with a Health Savings Account (HSA). In cases where an employee has a HDHP with a HSA, they are eligible for a Limited Expense FSA (LEX) (also called Limited Purpose FSA). These FSAs may be used to reimburse dental and vision expenses, regardless of any plan deductible; at the employers discretion, eligible medical expenses incurred after the deductible is met may also be reimbursable.
Coverage period
An FSA's coverage period ends either at the time the "plan year" ends for one's plan or at the time when one's coverage under that plan ends. Example: Loss of coverage due to a separation from the employer.This means that if, for example, a person is employed by a company from January through June and covered on their cafeteria benefits plan (including FSA) during that time, but does not elect and pay for continued coverage under that plan (i.e., COBRA
Consolidated Omnibus Budget Reconciliation Act of 1985
The Consolidated Omnibus Budget Reconciliation Act of 1985 is a law passed by the U.S. Congress on a reconciliation basis and signed by President Reagan that, among other things, mandates an insurance program giving some employees the ability to continue health insurance coverage after leaving...
), the person's coverage period is defined only as January through June, not January through December as one might think. In this example, all covered expenses must be incurred between January and June of that year.
Methods of withdrawal
In recent years, the FSA debit cardFSA debit card
An FSA Debit Card is a special type of debit card issued in the United States to access tax-favored spending accounts such as flexible spending accounts and health reimbursement accounts , and sometimes health savings accounts as well. All such cards to date bear the Visa, MasterCard, or...
was developed to eliminate "double-dipping," by allowing employees to access the FSA directly. It also simplified the substantiation requirement, which required labor-intensive claims processing. The debit card also enhances the effect of "pre-funding" medical FSAs. However, the substantiation requirement itself did not go away, and has even been expanded on by the IRS for the debit-card environment; therefore, withdrawal issues still remain for FSAs.
According to Celent, as of May 2006, there were approximately 6 million debit cards in the market tied to an FSA account, representing 25% of the FSA participating community. Celent projects that FSA cards will increase FSA adoption rates. The average card participation rate was around 20% as of May 2006. By 2010, it is projected this rate will increase to 85%.
Plan year grace period
In 2005, the Internal Revenue ServiceInternal Revenue Service
The Internal Revenue Service is the revenue service of the United States federal government. The agency is a bureau of the Department of the Treasury, and is under the immediate direction of the Commissioner of Internal Revenue...
authorized an optional 2½ month grace period
Grace period
A grace period is a time past the deadline for an obligation during which a late penalty that would have been imposed is waived. Grace periods, which can range from a number of minutes to a number of days or longer, depending on the context, can apply in various situations, including arrival at a...
that employers can use in their plans, allowing use of the funds for 2½ months after the end of the plan year.
Pre-funding and risks incurred by the employee and employer
One consideration regarding medical FSAs is that the participating employee's entire annual contribution is available at the start of the plan year, commonly January 1, or after the first contribution to the FSA is received by the FSA vendor, depending on the plan. Therefore, if the employee experiences a qualifying eventQualifying event
A qualifying event is an event that results in the loss of employer sponsored benefits due to which a qualified beneficiary is eligible for COBRA benefits....
during the first period, the entire amount of the annual contribution can be claimed against the FSA benefits. If the employee is terminated, quits, or is unable to return to work, he does not have to repay the money to the employer.
The employee contributes to the FSA in small increments throughout the year (for example, 1/26 of the annual amount if one is paid every 2 weeks), but taken together, all employees of a company contribute the full average amount during any given period, and no real risk is incurred by the employer. In addition, instead of paying payroll taxes to the government, the employer typically pays only a small administrative fee to the plan of $4–10 per participating employee. This is much less than the employer would have paid for its share of payroll taxes. In addition, any money that is not used by the end of the plan year (or grace period) is returned to the employer. This is estimated to be up to 14% of the total employee contributions, which can be a substantial boon to the employer's bottom line.
If a company plans to lay off some employees, and announces such plans, then if multiple employees use their entire flexible benefit before they are terminated, that may cause the company to have to reimburse the plan. Typically, however, employers do not announce layoffs for specific employees with enough notice for employees to use the available benefits, and employees may actually lose their contributions in addition to being laid off.
An employee does not continue to contribute to the plan upon termination of employment. Thus, one could use the entire amount on day one of the plan year, terminate employment on day two of the plan year, and contributions would have been none or negligible (e.g., perhaps 1/26 in the case of biweekly contributions). The "free" money is not taxable. The reason for this is that the IRS views these plans as health insurance plans for tax purposes. According to IRS section 125, benefits received from a health insurance plan are not considered taxable income.
The same reasons that make pre-funding a possible benefit to an employee participating in a plan make them a potential risk to employers setting up a plan. The employer has to make up the difference that the employee has spent from the flexible spending account but not yet contributed if other employees' contributions do not account for the money spent. The amount the employer loses due to pre-funding may eventually be partially, totally, or more than made up by employees that do not spend all of the money in their FSA account by the end of the plan year and grace period (see above).
Over-the-counter drugs and medical items
Another FSA feature that was introduced in 2003 is the ability to pay for over-the-counterOver-the-counter drug
Over-the-counter drugs are medicines that may be sold directly to a consumer without a prescription from a healthcare professional, as compared to prescription drugs, which may be sold only to consumers possessing a valid prescription...
(OTC) drugs and medical items. In addition to substantially expanding the range of "FSA-eligible" purchases, adding OTC items made it easier to "spend down" medical FSAs at year-end to avoid the dreaded "use it or lose it" rule.
However, substantiation has again become an issue; generally, OTC purchases require either manual claims or, for FSA debit card
FSA debit card
An FSA Debit Card is a special type of debit card issued in the United States to access tax-favored spending accounts such as flexible spending accounts and health reimbursement accounts , and sometimes health savings accounts as well. All such cards to date bear the Visa, MasterCard, or...
s, submission of receipts after the fact. Most FSA providers require that receipts show the complete name of the item; the abbreviations on many store receipts are incomprehensible to many claims offices. Also, some of the IRS rules on what is and isn't eligible have proven rather arcane in practice. The recently-developed inventory information approval system
Inventory information approval system
The Inventory Information Approval System, or IIAS, is a point-of-sale technology used by retailers that accept FSA debit cards, which are issued for use with medical flexible spending accounts , health reimbursement accounts , and some health savings accounts in the United States.By the end of...
(IIAS), separates eligible and ineligible items at the point-of-sale and provides for automatic debit-card substantiation.
However, drugs will have to have been prescribed to be reimbursable as of January 1, 2011 according to section 9003(f) of the Patient Protection and Affordable Care Act
Patient Protection and Affordable Care Act
The Patient Protection and Affordable Care Act is a United States federal statute signed into law by President Barack Obama on March 23, 2010. The law is the principal health care reform legislation of the 111th United States Congress...
.
Use it or lose it
A potential drawback is that the money must be spent "within the coverage period" as defined by the benefits cafeteria plan coverage definition. This coverage period is usually defined as the "period that you are covered" under the cafeteria plan during the "plan year". The "plan year" is commonly defined as the calendar year, but could also include the grace period of Jan. 1 - March 15 of the following year. For example, the "plan year" (or "benefit year") of 2012 would run from Jan. 1, 2012, until March 15, 2013, if the employer offered the grace period.Any money left unspent at the end of the coverage period is forfeited and can be applied to future plan administrative costs or can be equally allocated as taxable income among all plan participants; this is commonly known as the "use it or lose it" rule. Under most plans, the "coverage period" generally ceases upon termination of employment whether initiated by the employee or the employer, unless the employee continues coverage with the company under COBRA or other arrangement. An unfortunate possibility, especially in the case of unexpected, immediate layoff, is that should an employee have unused contributions in an FSA and no additional qualifying claims during the coverage period the employee will have the added insult of "losing" these funds. On the other hand, if the payroll taxes saved on the employee's contributions exceeds the amount the employee forfeited, then the employee has still saved money overall.
A second requirement is that all applications for refunds must be made by a date defined by the plan. If funds are forfeited, this does not eliminate the requirement to pay taxes on these funds if such taxes are required. For example, if a single person elects to withhold $5,000 for child care expenses and gets married to a non-working spouse, the $5,000 would become taxable. If this person did not submit claims by the required date, the $5,000 would be forfeited but taxes would still be owed on the amount.
Also, the annual contribution amount must remain the same throughout the year unless certain qualifying events occur, such as the birth of a child or death of a spouse.
Impact of health care reform
Health care reform legislation passed in March 2010 includes provisions that cap the amount that can be put into FSAs at $2,500 per employee. This change will take effect starting in 2013, and the cap will be annually adjusted for inflation thereafter.Starting in 2011, some FSA participants, depending on their plan, will no longer be able to receive reimbursements from an FSA for over-the-counter drugs and medicines without a doctor's prescription.
External links
- Official IRS site on Medical Expenses as a tax deduction - Explains which medical expenses are covered and which are not. (While this publication will generally also apply to the Medical Flex Spending benefit, some expenses listed in the publication are not eligible in the Medical Flex, including Long-Term care insurance, insurance premiums and expenses paid in the current year for services in prior years).
- FSAs and other tax-favored health plans - very helpful PDF from the IRS comparing these.
- A Fact Sheet on FSAs from the Employee Benefit Research Institute (EBRI), May 2007 [This is out dated now]
- A question and answer database on FSAs