Health FSAs and Dependent Care
Below, we've outlined the most important aspects of your health flexible spending account and dependent care assistance programs.
What You Need to Know
Here are some features of your health flexible spending account (FSA).
Under this rule, any unused funds in the health FSA at the end of the coverage period generally cannot be carried over to the next coverage period and must be forfeited. Exceptions apply for health FSAs with a grace period or carryover.
Grace periods - The Internal Revenue Service (IRS) allows employers to design their health FSA with an extended deadline, or grace period, of two and a half months after the end of a plan year to use FSA funds. Allowing a grace period is strictly optional and up to the employer. Also, a grace period is different from a "run-out" period, which gives participants time after the end of the coverage period to submit claims for medical expenses incurred during the coverage period.
Carryovers - A health FSA that allows carryovers cannot also have a grace period. Employers with health FSAs may allow up to $500 of unused funds remaining at the end of a coverage period to be paid or reimbursed to plan participants for qualified medical expenses incurred during the following coverage period.The remaining unused amount is what remains after reimbursements at the end of the run-out period.
The Affordable Care Act (ACA) limits employees' pre-tax health FSA contributions to $2,500 per year (as adjusted for inflation).
The ACA requires most health FSAs to qualify as "excepted benefits." This means that other health coverage must be offered and employer contributions to the health FSA are limited.
A health FSA can only reimburse employees for amounts spent on medical care, as defined under Internal Revenue Code (Code) Section 213(d). This section defines medical care as "the diagnosis, cure, mitigation, treatment, or prevention of disease, or for the purpose of affecting any structure or function of the body."
A health FSA can only reimburse medical care expenses that are not reimbursed elsewhere and that the employee does not claim a deduction for on their tax return. An employee must also be covered by the health FSA when the expense is incurred to be eligible for reimbursement.
Only the employee, employee's spouse, or employee's child (under age 27), or employee's tax dependent can contribute to eligible medical expenses.
Health FSA claims must be substantiated with information from a third party, such as a health care provider's bill.
Health FSA forfeitures occur when the contributions to the health FSA for a coverage period exceed reimbursements for that same period. In general, the simplest way to handle forfeitures is to use them to offset any experience losses.
Under the IRS' regulations, forfeitures may be retained by the employer maintaining the cafeteria plan, or they may be:
- Used to reduce required salary reduction amounts
- Returned to employees on a reasonable basis
- Used to defray expenses to administer the cafeteria plan
However, forfeitures that arise from participant contributions (as opposed to employer ones) are subject to duty rules and cannot be retained by the employer. Many employers choose to use the forfeitures to pay for reasonable administration expenses of the plan before looking at other options.
Here are some key parts of a dependent care assistance program (DCAP).
A DCAP, or dependent care FSA, is an employer-sponsored benefit plan that allows employees to pay for certain dependent care expenses on a tax-free basis, up to a specified limit. In most cases, DCAPs are funded by employees with pre-tax dollars through payroll deductions. When employees incur eligible dependent care expenses, such as babysitting or child care, they can seek reimbursement from their DCAP account.
The maximum amount that an employee may exclude from his or her income under a DCAP each year is limited to the smallest of the following amounts:
- $5,000 limit for an unmarried employee or a married employee who files a joint tax return (spouses filing jointly may not each claim $5,000 in DCAP benefits)
- $2,500 for a married employee who files separately
- The employee's earned income for the year
- The spouse's earned income, if the employee is married at the end of the year
participant elections must be made before the first day of the plan year and must remain in effect until the beginning of the next plan year. Participants typically cannot make changes to their cafeteria plan elections during a plan year.
However, IRS regulations permit employers to design their cafeteria plans to allow employees to change their elections during the plan year, if certain conditions are met. DCAPs may be designed to allow election changes when the following events occur:
- Change in status (i.e. number of dependents, employment status, place of residence)
- Changes in cost or coverage (i.e. child care provider changes their rates)
- Family Medical Leave Act (FMLA) leave
Dependent care expenses are eligible for reimbursement from a DCAP as otherwise unreimbursed work-related expenses and must satisfy the following two requirements:
- The expense must be primarily for the care of a qualifying individual
- The expense must be incurred in order to enable the employee (and spouse) to be gainfully employed
Qualifying individuals include:
- The taxpayer's dependent child who has not attained age 13
- The taxpayer's spouse who is mentally or physically incapable of self-care and has the same principal place of abode as the taxpayer for more than half the year
- A dependent of the taxpayer who is mentally or physically incapable of self-care and who has the same principal place of abode as the taxpayer for more than half the year
Other rules for reimbursement include the "Use or Lose" rule mentioned above.
