Employers offer a variety of plans for the tax benefit of employees. One such plan is the Flexible Spending Account (FSA) plan. In this article, we will explore FSAs in detail to understand their nuances.
What is FSA or Flexible Spending Account?
A Flexible Spending Account (FSA) is a type of account that allows employees to save their potential medical expenses. FSA is credited from an employee’s salary. Employers deduct the set amount decided by the employee from the remuneration before crediting their salary in their bank account. A few employers also contribute toward an employee’s FSA, and this amount is tax-free.
What is the Eligibility for Starting an FSA Plan?
Employers set up a health FSA for employees to avail benefits. Employers can provide an FSA with other employee benefits. Self-employed individuals are ineligible for an FSA.
FSA Contribution Rules
Employees contribute toward the FSA for their potential medical expenses in a year. An employer has the choice to contribute toward the employee FSA, but it is not compulsory.
An employee decides the amount they want to contribute toward the FSA at the start of every plan year. The employer deducts the set amount on each payday before crediting remuneration to the employee’s account. The arrangement is also called a salary reduction agreement. An employee doesn’t have to pay any tax on the amount contributed toward the FSA account.
FSA Fund Rules
- The amount contributed toward the FSA can not breach the USD 2750 threshold allowed under the FSA rules.
- An employee only has one year to use the FSA funds.
- If an employee doesn’t use the FSA fund within a year, the fund balance is transferred back to the employer’s account.
- There is a limit of USD 2750 per person. An employee’s spouse can also contribute up to the FSA fund limit if they are filing tax individually.
- Employers can offer a grace period for the FSA funds. For example, If the FSA plan expires on March 31, 2022, employers can extend it up to two and half months. An employee can use their FSA fund balance by June 15, 2022.
- Employers can allow carrying forward the fund balance by up to USD 550 per year till the next year.
FSA Distribution Rules
- FSA funds can only be used for qualified medical expenses.
- Employees can avail up to the maximum amount set for the health care FSA during any time of the year. For example, If an employee has set a limit of USD 2750 for the year, they can get the entire amount for the medical expense on the second day after the FSA plan starts.
- If an employee leaves the organization in the middle of the year and uses the entire FSA fund for that year, the company has to pay the remaining unpaid amount in FSA.
- The employee must provide a written statement that the amount used for the medical services hasn’t been reimbursed by other health coverage.
- The employee must provide a receipt or transaction details to get reimbursed by the health care FSA.
Changes in FSA Rules 2021
- IRS has released new guidelines that allow employees to change existing grace periods and amounts contributed toward FSA. However, the employer has the right to decide if they want to follow the guidelines in their organization.
- FSA coverage covers menstrual care products and unprescribed over-the-counter drugs, as of 2020.
What are Qualified Medical Expenses?
Qualified medical expenses under FSA include medical and dental expenses incurred by an individual during the year.
FSA covers qualified medical expenses incurred by the following persons.
- Employee and their spouse
- All dependents of the FSA holder
- Employee’s children under the age of 27 at the end of the tax year
- Ineligible dependents, including,
- An individual who has filed a joint return
- An individual whose gross income surpasses USD 4300
What are Health Care Flexible Spending Account Eligible Expenses?
- Vision-related expenses, such as spectacles, contact lenses, and prescription sunglasses are permitted.
- Dental expenses, such as dental care visits, braces, and other dental health expenses are acceptable.
- The FSA plan covers menstrual care products and unprescribed over-the-counter drugs, as per the flexible spending account rules 2020.
- Broad categories of products covered under the FSA are as follows.
- Baby and child care
- Ear care
- Foot health
- Family planning and tests
- Medical equipment
- FSA holders can refer to the IRS Publication 502 to understand medical expenses permitted under the FSA.
- Health insurance premiums, long-care expenses, and expenses covered by other health plans are not covered under FSA.
What is an FSA Card?
An FSA card works like a debit card and allows individuals to spend money under the FSA. An individual can use their FSA card for eligible expenses under the FSA plan. FSA cards can be used at hospitals, pharmacies, and online FSA stores, including Amazon FSA. If the service provider of your qualifying expense doesn’t accept an FSA card, you can withdraw cash to make a payment. However, you need to save the receipt for the FSA provider and IRS audit. If a person uses an FSA card for ineligible expenses, they have to credit their account with the same amount. An individual can view their FSA card balance from an online FSA account. FSA cards may or may not be provided by the employee’s FSA plan.
What is Dependent Care FSA?
American families find it challenging to manage child care when they go to work. They need child care support to help them relieve the concern of looking after their children. Dependent care FSA covers child care expenses for dependent children up to 13 years of age. In addition, dependent care FSA also allows adult care expenses when a dependent adult is incapable of self-care.
What is the Eligibility for the Dependent Care FSA Plan?
Employers set up a dependent care FSA for an employee to avail of the benefits. Employers can provide dependent care FSA with other employee benefits. Self-employed individuals are ineligible for dependent care FSA.
What are the Dependent Care FSA Contribution Rules?
An employee decides the amount they want to contribute toward the dependent care FSA for the yearly child care and adult care expenses. The employer deducts the amount on every payday toward the annual dependent care FSA fund. An employee can deduct the amount contributed toward the dependent care FSA from their gross salary and receive tax benefits.
What are the Rules for the Dependent Care Contribution Toward the Fund?
- The amount contributed toward the FSA can not breach the USD 2500 threshold allowed under the dependent care FSA rules.
- Employees only have one year to use the FSA funds. The fund balance will be transferred into the employer’s account if not used.
- The limit of USD 2500 applies per person. Employees’ spouses can contribute up to the FSA fund limit.
- Employers can offer a grace period for the FSA funds. For example, if the dependent care FSA plan expires on December 31, 2021, the employer can extend it by up to two and half months, and the employee can use their FSA fund balance by January 15, 2022.
- Employers can allow the carrying forward of the fund balance of up to USD 550 per year to the succeeding year.
What are the Dependent Care FSA Distribution Rules?
- The dependent care FSA funds can only be used for qualified medical expenses.
- Employees can avail of funds up to the maximum amount they have decided to contribute to the dependent care FSA at any time of the year. For example, If an employee has set a limit of USD 2500 for the year, they can get the entire amount for the care expense from the second day after the FSA plan starts.
- If employees leave the organization in the middle of the year and use the entire dependent care FSA fund agreed upon for that year, the company has to pay the remaining unpaid amount.
- The employee must provide a receipt or transaction details to get a reimbursement amount from dependent care FSAs.
What are the Eligible Dependent Care FSA Expenses?
- Physical care
- An expense for a nanny or babysitter
- Summer day camps for children
- Child daycare or adult daycare services
- Before and after school care (tuition excluded)
- Nursery schools
What is a Limited Purpose FSA (LPFSA)?
An individual can not have both HSA and healthcare FSA. An employer provides the option for an employee to apply for a Limited Purpose FSA with the HSA. An employee can use the LPFSA for dental and vision expenses. Employees who have HSA can get medical expenses for vision and dental care through LPFSA.
What is the Eligibility for Starting a Limited Purpose FSA Plan?
Employers set up the LPFSA for employees. If employers fail to provide an LPFSA plan, an individual cannot get the benefit of LPFSA. Self-employed individuals cannot avail of an LPFSA plan.
What are the Rules for Limited Purpose FSA Funds?
- The amount contributed toward the LPFSA cannot breach the USD 2750 threshold allowed under the LPFSA rules. If an employee and their spouse are filing the tax individually, they can contribute USD 2750 each toward the Limited Purpose FSA.
- An employee only has one year to use the LPFSA funds.
- If an employee doesn’t use the FSA fund within a year, the fund balance is transferred into the employer’s account.
- Employers can offer a grace period for the FSA funds. For example, If the dependent care FSA plan expires on December 31, 2021, the employer can extend it by up to two and half months, and the employee can use their FSA fund balance by January 15, 2022.
- Employers can allow the carrying forward of the fund balance of up to USD 550 per year to the subsequent year.
What are the Limited Purpose FSA Eligible Expenses?
- Limited Purpose FSA eligible expenses include vision expenses for items such as spectacles, prescription sunglasses, and lens cleaner solutions.
- LPFSA covers dental expenses such as dental cleaning and filling.
- LPFSA holders can refer to the IRS Publication 502 to understand medical expenses.
Example of LPFSA
Let’s say Alexa has the following eligible expenses.
|USD 50||100% covered by insurance|
One dental filling
100% covered by insurance
|Prescription sunglasses||USD 200|
Covered by LPFSA, not insurance
|Eye exam||USD 75|
80% covered by insurance, and the rest used by LPFSA
Alexa can calculate her potential expenses for vision and dental care in the following year. She can put the amount in LPFSA not covered under her current insurance plan and avail of tax benefits.
An employer can create and offer various Flexible Spending Accounts to their employees. The IRS regularly updates the rules to include, remove, or update different rules. The employer needs to change their FSA plans accordingly, to offer an employee new benefits.