Flexible Spending Accounts

Introduction:

A Flexible Spending Arrangement, commonly referred to as Flexible Spending Account or FSA, is an IRS approved mechanism to pay for eligible expenses with pre-tax dollars.  Accounts are set up annually and may be funded by employee payroll reductions or by employer contributions.  Any contributions to an FSA by either the employee or employer are excludable from gross income; in other words, no state or federal income taxes or employment taxes are paid on the contributions resulting in substantial tax savings for the participant.  Once an election is made it continues unchanged for the duration of the plan year unless there is a change in employment or family status.  Unspent contributions remaining at the end of a plan year are subject in varying degrees to the “use it or lose it” rule as discussed more fully below.  

Two of the most common types of FSA are Medical Expense FSA and Dependent Care FSA.  Medical Expense FSA may be used to reimburse eligible medical expenses incurred by the participant, his/her (same- or opposite-sex) spouse, qualifying child or qualifying relative; a Dependent Care FSA  may be used to reimburse eligible day care expenses which permit the participant and spouse to work.    Access to FSA funds may be direct through the use of a debit card or may be available through traditional paper claim submission with the resulting reimbursement through check or direct deposit.   Once an annual election is made, Dependent Care funds become available for purposes of reimbursement as they are deducted from the participant’s paycheck.  With the Medical Expense FSA and because of the uniform coverage rule, the full amount of the annual election is available for reimbursement on the first day of the plan year.  With an FSA, participants benefit by having less taxable income in their paychecks, which means more spendable income to use toward eligible medical and dependent care expenses and lower taxes at tax time.  For example:

 

Savings Chart:

FSA Savings Example
With FSA   Without FSA
$31,000
Annual Gross Income
$31,000
- 2,500   
FSA Deposit for Recurring Expenses
- 0          
$28,500
Taxable Gross Income
$31,000
- 6,455.25   
Federal, Social Security Taxes
- 7,021.50    
$22,044.75
Annual Net Income
$23,978.50
- 0          
Costing of Recurring Expenses
- 2,500   
$22,044.75
Spendable Income
$21,478.50

By using a FSA to pay for anticipated recurring expenses, you convert the money you save in taxes to additional spendable income. That's a potential annual savings of

$566.25!
 

 

By using an FSA to pay for anticipated expenses, the tax savings converts to spendable income. That's a potential annual savings of $566.25!

 

Medical FSA:

A Medical Expense FSA (MFSA) may only be used to pay for eligible medical expenses as defined under Internal Revenue Code.   It is a “family” account, meaning that the participant may cover eligible out of pocket medical expenses  incurred by the participant, his/her (same- or opposite-sex) spouse or a qualifying child or relative (defined below).   Unlike the Dependent Care FSA, the full amount a participant elects to contribute over the course of the year is available to use at the beginning of the plan year rather than waiting for the money to accumulate in the account on a payroll basis.

Beginning with plan years effective in 2013 the maximum annual contribution an employee may make to an MFSA is $2,500; this maximum may be indexed annually by the IRS.  Note: employer contributions to the MFSA are not included in the maximum contribution calculation.  Employers may further limit the contribution by plan design to reduce their exposure under the uniform coverage rule.  Under IRS rules, the MFSA is treated like insurance and uniform coverage means that an employee may incur an expense on day one of the plan year and deplete his/her entire account balance even though the account has not yet received all payroll contributions.   If this employee separates from service before all payroll contributions are deposited into the account, the employer will suffer an experience loss because it reimbursed the full amount of the incurred expense.    An employer may not ask the employee to return any overpaid funds.  Participants also have some risk and it is important to calculate out of pocket medical expenses accurately when determining an annual amount to contribute to an MFSA. The IRS permits employers to provide some relief; for example: an employer may offer a two month and fifteen day grace period at the end of a plan year for participants to incur additional eligible expenses.  At the end of the grace period, any remaining funds in the MFSA are forfeited by the participant.  Another relief option is for an employer to offer a carryover provision whereby an employee may carry forward to the next plan year up to $500 of any remaining MFSA balance existing at the end of the plan year.  An employer may only offer one of the options and is not required to offer either one.  

There is an IRS permitted run-out period which creates an extended period for filing claims incurred during the plan year or grace period (if offered); the runout period is generally ninety days after the end of the plan year.  Purchases with an MFSA must meet IRS rules which determine eligible medical expenses.  Generally expenses which treat or prevent a specific medical condition will be eligible for reimbursement.  This can be as significant as diabetes or pregnancy, or as minor as a skin cut. Certain items cannot be purchased using an MFSA, see the list below for some examples of eligible and ineligible expenses.

 

Partial List of Medically Necessary Eligible Expenses:

  • Acupuncture
  • Ambulance service
  • Birth control pills and devices
  • Chiropractic care
  • Contact lenses (corrective)
  • Dental fees
  • Diagnostic tests/health screening
  • Doctor fees
  • Drug addiction/alcoholism treatment
  • Drugs
  • Experimental medical treatment
  • Eyeglasses
  • Guide dogs
  • Hearing aids and exams
  • In vitro fertilization
  • Injections and vaccinations
  • Nursing services
  • Optometrist fees
  • Orthodontic treatment
  • Over-the-Counter Medicine
  • Prescription drugs to alleviate nicotine withdrawal symptoms
  • Smoking cessation programs/treatments
  • Surgery
  • Transportation for medical care
  • Weight-loss programs/meetings
  • Wheelchairs
  • X-rays

Partial List of Ineligible Expenses:

  • Insurance premiums
  • Vision warranties and service contracts
  • Cosmetic surgery not deemed medically necessary to alleviate, mitigate or prevent a medical condition

 

Dependent Care FSA:

A Dependent Care FSA (DFSA) is an excellent way to pay for eligible dependent care expenses such as after school care, baby-sitting fees, day care services, nursery and preschool. While most commonly used for childcare, it can also be used for adult day care for senior citizen dependents that live with the participant, such as parents or grandparents. It cannot be used for summer camps (other than "day camps") or for long-term care for parents that live elsewhere (such as in a nursing home). Eligible dependents include the participant’s qualifying child, spouse and/or qualifying relative.

The DFSA has a $5,000 federal limit on the maximum contribution amount per plan year (certain exceptions and rules apply to this limit). Married (same- or opposite-sex) spouses can each elect to have this amount deducted from their paycheck and applied to expenses. However, at tax time all withdrawals in excess of the $5,000 are taxed. Unmarried couples can deduct and use $5,000 each.

 

For a DCFSA –

Minimum Annual Deposit: Determined by employer

Maximum Annual Deposit: Depends on participant’s tax filing status 

  • If married and filing separately, the maximum annual deposit is $2,500.
  • If single and head of household, the maximum annual deposit is $5,000.
  • If you are single and not head of household, your maximum annual deposit is $2,500.
  • If married and filing jointly, the maximum annual deposit is $5,000.
  • If either the participant or spouse earns less than $5,000 a year, your maximum annual deposit is equal to the lower of the two incomes.
  • If the participant’s spouse is a full-time student or incapable of self-care, the maximum annual deposit is $3,000 a year for one dependent, and $5,000 a year for two or more dependents.

If married, BOTH spouses must earn income in order for the DCFSA to work. The only exception is if the non-earning spouse is disabled or a student. If one spouse earns less than $5,000 then the benefit is limited to whatever that spouse earned.

DFSAs do not rely on the uniform coverage rule applicable to Medical Expense FSAs; employees receive reimbursement as funds are deposited into the DFSA. They may be used to receive reimbursement for eligible dependent care expenses for qualifying individuals.

 

A qualifying child:

  • Is a U.S. citizen, national or a resident of the U.S., Mexico or Canada
  • Has a specified family-type relationship to the participant
  • Lives in the participant’s household for more than half of the taxable year
  • Is 12 years old or younger and
  • Has not provided more than one-half of their own support during the taxable year.

A participant’s spouse:

  • Is physically and/or mentally incapable of self-care
  • Lives in the participant’s household for more than half of the taxable year and
  • Spends at least eight hours per day in the participant’s home.

A qualifying relative:

  • Is a U.S. citizen, national or a resident of the U.S., Mexico or Canada
  • Is physically and/or mentally incapable of self-care
  • Is not someone else’s qualifying child
  • Lives in the participant’s household for more than half of the taxable year
  • Spends at least eight hours per day in the participant’s home and
  • Receives more than one-half of their support from the participant during the taxable year.

Remember, only the custodial parent of divorced or legally separated parents can be reimbursed using a DCFSA.

It is important to budget appropriately when selecting a contribution amount. All funds that are left over in the account at the end of the plan year cannot be carried over to the next year or refunded. There is an IRS permitted grace period, and some employers have a run-out period in addition to this, which creates an extended period for filing claims and/or using funds beyond the plan year.

Partial List of Eligible Dependent Care Expenses:

  • After school care
  • Baby-sitting fees
  • Day care services
  • In-home care/au pair services
  • Nursery and preschool
  • Summer day camps

Partial List of Ineligible Expenses:

  • Books and supplies
  • Child support payments or child care if you are a non-custodial parent
  • Health care or educational tuition costs and
  • Services provided by the participant’s dependent, spouse’s dependent or participant’s child who is under age 19.

This article is intended to provide accurate and authoritative information on the subject matter covered. It is distributed with the understanding that FBMC is not rendering professional or medical advice and assumes no liability in connection with its use.

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