Flexible spending arrangement
A health flexible spending arrangement (FSA), alternately known as a flexible spending account, allows employees to be reimbursed for medical expenses. FSAs are usually funded through voluntary salary reduction agreements with your employer. No employment or federal income taxes are deducted from your contribution. The employer may also contribute.
There are several benefits from having an FSA:
- Contributions made by your employer can be excluded from your gross income
- No employment or federal income taxes are deducted from the contributions, which reduces the amount of tax withdrawn from your salary.
- Withdrawals may be tax free if you pay qualified medical expenses (see Qualified Medical Expenses).
- You can withdraw funds from the account to pay qualified medical expenses even if you have not yet placed the funds in the account.
Qualifying for an FSA
Health FSAs are employer-established benefit plans. These may be offered in conjunction with other employer-provided benefits as part of a cafeteria plan. Employers have complete flexibility to offer various combinations of benefits in designing their plan. You do not have to be covered under any other health care plan to participate.
- Self-employed persons are not eligible for an FSA.
- Certain limitations may apply if you are a highly compensated participant or a key employee.
- If you contribute to a general-purpose FSA, commonly called a health, healthcare or medical FSA, you may not contribute to a Health savings account (HSA) even if you have an otherwise-qualifying High Deductible Health Plan. One may, however contribute to both a HSA and a limited-purpose FSA.
Contributions to an FSA
You contribute to your FSA by electing an amount to be voluntarily withheld from your pay by your employer. This is sometimes called a salary reduction agreement. The employer may also contribute to your FSA if specified in the plan.
You do not pay federal income tax or employment taxes on the salary you contribute or the amounts your employer contributes to the FSA. However, contributions made by your employer to provide coverage for long-term care insurance must be included in income.
When to contribute
At the beginning of the plan year, you must designate how much you want to contribute. Then, your employer will deduct amounts periodically (generally, every payday) in accordance with your annual election. You can change or revoke your election only if there is a change in your employment or family status that is specified by the plan.
Amount of contribution
Generally, contributed amounts that are not spent by the end the plan year are forfeited (see Balance in an FSA), later. For this reason, it is important to base your contribution on an estimate of the qualifying expenses you will have during the year.
Distributions from an FSA
Generally, distributions from a health FSA must be paid only to reimburse you for qualified medical expenses you incurred during the period of coverage. You must be able to receive the maximum amount of reimbursement (the amount you have elected to contribute for the year) at any time during the coverage period, regardless of the amount you have actually contributed. The maximum amount you can receive tax free is the total amount you elected to contribute to the health FSA for the year.
You must provide the health FSA with a written statement from an independent third party stating that the medical expense has been incurred and the amount of the expense. You must also provide a written statement that the expense has not been paid or reimbursed under any other health plan coverage. The FSA cannot make advance reimbursements of future or projected expenses.
Debit cards, credit cards, and stored value cards given to you by your employer can be used to reimburse participants in a health FSA. If the use of these cards meets certain substantiation methods, you may not have to provide additional information to the health FSA.
Qualified medical expenses
Qualified medical expenses are those specified in the plan that would generally qualify for the medical and dental expenses deduction. These are explained in IRS Publication 502. However, even though non-prescription medicines (other than insulin) do not qualify for the medical and dental expenses deduction, they do qualify as expenses for FSA purposes.
You cannot receive distributions from your FSA for the following expenses.
- Amounts paid for health insurance premiums.
- Amounts paid for long-term care coverage or expenses.
- Amounts that are covered under another health plan.
You cannot deduct qualified medical expenses as an itemized deduction on Schedule A (Form 1040) that are equal to the distribution you receive from the FSA.
Balance in an FSA
Flexible spending accounts are use-it-or-lose-it plans. This means that amounts in the account at the end of the plan year cannot be carried over to the next year. However, the plan can provide for a grace period of up to 2½ months after the end of the plan year. If there is a grace period, any qualified medical expenses incurred in that period can be paid from any amounts left in the account at the end of the previous year. Your employer is not permitted to refund any part of the balance to you.
Plans may allow up to $500 of unused amounts remaining at the end of the plan year to be paid or reimbursed for qualified medical expenses you incur in the following plan year. The plan may specify a lower dollar amount as the maximum carryover amount. If the plan permits a carryover, any unused amounts in excess of the carryover amount are forfeited. The carryover doesn’t affect the maximum amount of salary reduction contributions that you are permitted to make.
A plan may allow either the grace period or a carryover, but it may not allow both.
A limited-purpose FSA (LPFSA) is a type of FSA that covers only qualifying dental and vision care.
A LPFSA is a different classification of FSA account compared to a standard health FSA. You cannot sign up for a health FSA and simply use it only for qualifying medical and dental expenses and claim it is a LPFSA; you must be sure that you are signing up for a FSA that is explicitly designated as a LPFSA.
Not all employers who offer a health FSA also offer a LPFSA.
A HSA combined with a LPFSA offers employees the ability to maximize their tax-advantaged savings. As with a standard FSA, an individual contemplating a LPFSA should attempt to estimate anticipated dental and vision expenses to avoid forfeiting unused balances.
If an individual is not enrolled in a HSA, then there is no reason to choose a LPFSA over a FSA.
- IRS Pub. 969 - Qualifying for an HSA - Other employee health plans
- Public Law 111 - 148 - Patient Protection and Affordable Care Act, Sections 9005 and 10902 from the U.S. Government Printing Office. The starting date was amended to 2013 in Public Law 111 - 152 - Health Care and Education Reconciliation Act of 2010, Section 1403. The final law is in 26 U.S.C. 125 - Cafeteria plans (Internal Revenue Code) Amendment of Subsection(I).
- Revenue Procedure 19-44, from the IRS.
- "Publication 969 (2017), Health Savings Accounts and Other Tax-Favored Health Plans". IRS. 08 Mar 2018. https://www.irs.gov/publications/p969.
- IRS Publication 502, Medical and Dental Expenses
- IRS Publication 502, Medical and Dental Expenses: Online version or PDF
- IRS Publication 969, Health Savings Accounts and Other Tax-Favored Health Plans: Online version or PDF
- Flexible Spending Account, on Wikipedia
- Celebrate the FSA - thread in Bogleheads.org forum