Flexible Spending Accounts (FSA)

Employers may offer a health Flexible Spending Account (FSA) as part of their employee benefits programs. The FSA is funded by contributions from the employer and/or from employee salary reduction. The money can be used to reimburse employees for expenses related to medical insurance deductibles and co-pays, out-of-pocket medical treatments or supplies, and dependent healthcare expenses.

When employees contribute to a flexible spending arrangement, no employment or federal income taxes are deducted from the contribution. Any contributions to an FSA by an employer are excluded from the employee’s gross income which reduces the tax payments of the employer. Both employee and employer save money when using an FSA.

Health FSAs may be offered with other employer-provided benefits in a cafeteria plan. Employers have the flexibility to offer many combinations of benefits depending on how they design their plans. Employees are not required to have any other insurance to participate. Self-employed people cannot have a Health FSA.

Note that any money remaining in a flexible spending account at the end of the plan year cannot be carried over to the next year.

An FSA is allowed under the Internal Revenue Code Section 125 and covers all pre-tax dollars for non-reimbursed medical, dental and dependent care expenses. Other items that may be covered include insurance premiums, deductibles, co-payments, and non-covered services.

FSA deductions are removed from the employee’s paycheck before taxes, resulting in more take-home amount for the employee. Reimbursement requests under a Section 125 flexible spending plan are often submitted to a third party administrator, like Rocky Mountain Reserve. All claims will be verified for eligibility and paid out in a timely manner. This reduces nearly all of the employer’s administrative work associated with this benefit.

FSA and DCAP

The FSA program gives employees coverage on health-related expenses, subject to certain maximum amounts and reasonable conditions. Eyeglasses and orthodontia are two examples of health FSA expenses. Health FSAs are not allowed to reimburse insurance premiums.

Typical Health FSA. A cafeteria plan lets participants elect coverage under a health FSA with an annual limit up to $2,500—for example, $1,200. They pay for that coverage with pre-tax salary reduction dollars. The health FSA reimburses employees for medical and dental expenses not otherwise reimbursed (and for which participants will not seek reimbursement) under any other plan. A participant who elects the maximum $1,200 of coverage must reduce his or her annual taxable wages by $1,200 (the annual premium), thereby paying for the coverage with pre-tax dollars. Why would someone reduce their pay by $1,200 just to get the $1,200 back as reimbursement for medical expenses? The answer is, to realize tax savings under the health FSA.

DCAP stands for Dependent Care Assistance Program and is also a Flexible Spending Account. An employee can use a DCAP to be reimbursed for employment-related expenses that allow the employee and his or her spouse to be “gainfully employed.” Employment-related expenses apply only to certain individuals. Typical DCAP expenses are those incurred to have a babysitter or day-care provider take care of an employee’s child (under the age of 13) while Mom and Dad are both working, or to take care of a spouse or other tax dependent who lives with the employee and is incapable of self-care.

Typical DCAP. A cafeteria plan lets participants elect coverage under a DCAP with an annual limit of up to $5,000. They pay for that coverage with pre-tax salary reduction dollars. At the end of each month, the DCAP reimburses the dependent care expenses that they incur during the month. Assume that Jane elects the full $5,000 of coverage. She must reduce her taxable wages by $5,000 (the annual premium) to pay for the coverage. By participating in the DCAP, Jane would achieve tax savings but subject to additional factors that affect the calculation of the tax savings.

Like cafeteria plans, all FSAs must meet certain legal requirements. For example, only expenses that are incurred during the plan year can be reimbursed. “Incurred” means that services giving rise to the expense were provided. It does not matter when the expenses are paid. For example, an expense is incurred when an individual visits the medical practitioner, not when the practitioner’s bill is received or paid by the patient.