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Flexible Spending Accounts

Flexible Spending Accounts (FSAs), often referred to as "cafeteria plans," are regulated by Section 125 of the Internal Revenue Code. An FSA will allow employees to pay for eligible premium expenses with pre-tax dollars. In addition, participants can fund eligible medical and dependent care expenses with pre-tax dollars. By participating in an FSA, employee contributions effectively reduce taxable income, as contributions are not subject to federal withholding, FICA, and often state withholding, unemployment and workers' compensation taxes. By offering these plans, the employers' tax liability is also reduced.

Types of Flexible Spending Accounts

  • Premium-Only Plans (POP)
    These plans allow employees to pay their portion of premium contributions for employer-sponsored health plans on a pre-tax basis. Typically, premiums for medical, dental and vision plans qualify for pre-tax contributions.
  • Health Care Reimbursement Accounts (HCRA)
    Employees can set aside pre-tax contributions for eligible out-of-pocket health care expenses. Examples of eligible expenses include co-pays, coinsurance and deductibles. Benefits and services that are limited by underlying health plans can also be reimbursed by an HCRA; for example; chiropractic care, orthodontic expenses and eligible over-the-counter medications.
  • Dependent Care Reimbursement Accounts (DCRA)
    This type of FSA allows employees to pay for eligible, work-related dependent care on a pre-tax basis. Examples include baby-sitters, nursery schools, pre-schools, and day care centers. Eligible expenses can include care for a family member who is physically or mentally incapable of self care and qualifies as a tax-dependent.

Use It or Lose It Requirement

The IRS also requires FSAs to contain an element of risk. That is, amounts elected by participants to fund the FSA must be used by the end of the plan year or are forfeited. Though not mandatory, employers may choose to adopt a 2½ month grace period allowing participants to reimburse expenses incurred during the 2½ month period following the end of a plan year with unused contributions from the prior year.

Eligibility Considerations

The IRC rules governing Flexible Spending Account plans do not allow discrimination in favor of "highly compensated" employees. Plans must undergo regular "non-discrimination" testing to ensure plan documentation complies with IRC regulation.

Debit Cards

The IRS allows the use of debit cards for purchasing eligible expenses reimbursed by FSA plans. Because of the convenience of using debit cards, increased participation by employees in a FSA can result. However, the IRS only allows for purchases for eligible expenses from merchants providing assigned merchant category codes or with inventory information approval systems. Benefit expense substantiation is required.

Additional Resources