(Last Updated: ~~ March 24, 2008 - Information May Have Changed)
Health care flexible spending accounts (FSA) allow employees to pay for certain unreimbursed health care and dependent care expenses with before-tax dollars. For most employees, flexible spending accounts provide a better tax benefit than is available to them as an individual taxpayer. For employers, flexible spending accounts can significantly enhance an employer's overall benefits program and/or reduce some of the pain of the inevitable cutback in benefits to employees.
As health care premiums continue to increase at a rapid rate, employers are continually shifting costs to employees in the form of higher co-pays, deductibles and out-of-pocket costs. To help offset some of the sting associated with these higher out-of-pocket expenses many employers are implementing Flexible Spending Accounts (FSA) for health care.
How to Participate in Flexible Spending Accounts
To participate in flexible spending accounts, employees are required to make irrevocable benefit elections prior to the beginning of each plan year. When making an election to participate in flexible spending accounts, employees must carefully specify how much, if any, pre-tax salary they wish to contribute to the plan. It is important that employees carefully estimate the amount they believe they might spend in the upcoming year because money not spent is forfeited.
What Medical Expenses Are Reimbursed Through Flexible Spending Accounts?
Medical expenses that may be reimbursed through flexible spending accounts are those that are excludable from gross income under tax code Section 213, and are not reimbursable under any other health plan coverage. This could include expenses for:
- Dental services,
- Percentages of insurance premiums,
- Prescription drugs,
- Over the counter medications, when prescribed by a physician,
- Emergency ambulance service,
- Chiropractic services,
- Eyeglasses, including contact lenses,
- Hearing devices, and
- Psychiatric care.
Complete information is available from your employer and from the IRS. The IRS provides a comprehensive list of eligible expenses for flexible spending accounts.
When May Employees Make Changes in Flexible Spending Accounts?
While the election to participate in flexible spending account plans is made annually, plan sponsors may permit employees to make changes in benefit elections only under the following conditions:
- Change in legal marital status,
- Change in number of dependents,
- Change in employment status,
- Change in work schedule that changes a participant’s eligibility in the plan,
- Dependent satisfies or ceases to satisfy eligibility requirements,
- Significant change of residence or work-site, and
- Judgment decrees or orders pertaining to child or spouse.
Flexible spending accounts may reimburse employees only for qualified expenses that are incurred during the plan's "period of coverage." (Expenses are incurred in flexible spending accounts only after the service or item has been provided, not when the employee is formally billed or pays for the service.) The period of coverage for medical or dependent care flexible spending accounts is twelve months. In cases where an employer has a short first plan year or where the flexible spending account's year is being changed, the period of coverage must be the entire short plan year.
Employees who terminate their employment before the end of the flexible spending account year have several options. They may forfeit their flexible spending account balances, if they fail to continue scheduled contributions and revoke their benefit elections; or, they may continue to contribute to the flexible spending account through COBRA until year's end, thereby continuing to be covered by the plan until the end of the plan year.
Flexible Spending Accounts Forfeitures
If flexible spending accounts have forfeitures at the end of the plan year, employers may use forfeitures toward offsetting reasonable administrative costs incurred during the plan year.
Or, employers may credit experience gains to employees' flexible spending accounts in the following plan year, as long as the funds are allocated on a reasonable and uniform basis to all of the flexible spending account participants.
The funds may be allocated on a per capita basis or according to the level of coverage selected under the flexible spending account. In no event may a participant’s forfeiture be returned directly to the participant.
Flexible Spending Accounts Claims
Employees' flexible spending account claims are reimbursed when the employee provides the plan administrator with the following information:
- A written statement from an independent third party stating that the expense has been incurred and stating the amount of the expense, and
- A statement that the expense has not been reimbursed and is not reimbursable under any other health plan coverage.
Recently, reimbursement under flexible spending account plans has become more convenient for plan sponsors who offer participants the option of using a debit card. The benefits of using a debit card are:
- Direct access to pre-tax money in the FSA plan,
- No need to pay cash upfront and wait for reimbursement, and
- Reduced paperwork.
IRS Changes Improve Access to Flexible Spending Accounts
January 1, 2008 brought an update to the flexible spending account Debit Card technology. The IRS approved Inventory Information Approval System (IIAS) which is a point-of-sale technology in which retailers auto-substantiate eligible healthcare expenses at the point of sale. The point-of-sale terminal will automatically separate the purchase into flexible spending account eligible or ineligible categories. Only the items identified as health care approved will be processed for payment with the flexible spending account Debit Card and another form of payment is required for ineligible items.
As a result, cardholders do not need to provide receipts to verify the eligibility of prescriptions for over-the-counter (OTC) items, making the process even easier for participants. The IRS still requires participants to retain their receipts for their records.
At the same time, the IRS required all supermarkets, discount stores, grocery stores, wholesale clubs and mail order merchants to implement IIAS. The flexible spending account Debit Card will be declined at non-health merchants that are not IIAS certified.
Tax Advantages With Flexible Spending Accounts
In addition to employee tax advantages, flexible spending accounts for health care programs provide significant employer tax benefits, as well. (While partnerships, sole proprietors and Sub-chapter S Corporations may sponsor cafeteria plans, the following cannot participate: sole proprietors, partners and greater than 2% shareholders in Sub-chapter S corporations. Also partners of LLPs or LLCs are not permitted to participate in a cafeteria plan.)
Employer matching FICA taxes are reduced proportionally for every dollar employees contribute to their flexible spending accounts. In some instances, this can create an opportunity to offer a benefit to employees for no cost. While the benefits of FICA savings and employee tax savings are clear, many plan sponsors are often concerned about their exposure as it pertains to the “Universal Coverage” rule.
Risk for Employers Who Offer Flexible Spending Accounts for Health Care
The uniform coverage rule requires healthcare expense flexible spending account plans to operate like insurance plans, rather than mere reimbursement accounts. This means that employers must make the full amount of coverage elected by a flexible spending account plan participant available to the employee from the start of the plan year, regardless of how much has been paid into the account up to that point. Employers may not deduct from employees' final paychecks flexible spending account premium payments that are due for the rest of the year as a method of minimizing their loss.
While there is no mitigating the risk of flexible spending accounts, in most instances the concern is unwarranted. In a three year study of an average of 236 flexible spending account plans covering over 15,000 plan participants, 76% of the plans generated plan forfeitures to employers while only 21% experienced a loss. (On average, 3% of flexible spending accounts plans netted zero during the study period.) The average forfeiture to plan sponsors was $2,159 while the average loss was only $508.71.
Overall, flexible spending accounts are one of the only employee benefits programs available that can provide such significant employee and employer tax savings at such a low cost.Find out what a Health Care Flexible Spending Account (FSA) can do for your employees.