Flexible benefit plans, often referred to as “cafeteria plans” are regulated by Section 125 of the Internal Revenue Code (IRC). Cafeteria plans allow employees to pay for eligible premium expenses with pre-tax dollars. 

In addition, these plans allow participants to fund for eligible medical and dependent care expenses with pre-tax dollars.  By participating in a FSA, employee contributions effectively reduce taxable income – contributions are not subject to federal withholding, FICA and often state withholding, unemployment and workers’ compensation taxes.  As such, by offering these plans the employers’ tax liability is also reduced.

Types of Flexible Spending Accounts:

• Premium Only Plans or “POP” plans
  
  
• Health Care Reimbursement Accounts (HCRA)
  
  
• Dependent Care Reimbursement Accounts (DCRA)

Premium Only “POP” Plans:
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 copays, coinsurance, and deductibles.  In addition, benefits and services that are limited by the underlying health plans can also be reimbursed by a HCRA – for example, chiropractic care, orthodontic expenses and eligible over-the-counter medications.  (For a complete list of current eligible expenses please refer to IRS publication 502 – link provided below.)

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. Also, eligible expenses can include care for a family member who is physically or mentally incapable of caring for themselves 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. This “use it or lose it” concept has recently been softened by the introduction of a 2 ½ month grace period. Though not mandatory, employers may choose to adopt this grace period allowing participants to reimburse expenses incurred during the 2 ½ month period following the end of a plan year with unused contributions from the prior year.

Eligibility Considerations
The IRC rules governing flexible benefit plans do not allow discrimination in favor of “highly compensated” employees. These rules include eligibility in, and utilization of these plans. As a result, plans need to undergo regular “non-discrimination” testing and ensure that 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 in using debit cards, increased participation by employees in a FSA can result. However, only purchases for eligible expenses from merchants assigned “merchant category codes” or those merchants with inventory information approval systems are allowed by the IRS – benefit expense “substantiation” is still required.

Additional Resources:
Ceridian - “Frequently Asked Questions about Flexible Spending Accounts”
Department of the Treasury (IRS) – Publication 502 “Medical and Dental Expenses”