Health Flexible Spending Accounts (FSAs)
A health FSA (flexible spending account) is a type of tax-advantaged medical account that reimburses employees for eligible health care expenses that are not covered by their health plans. Both employees and employers can contribute to a health FSA, subject to certain limits on a tax-advantaged basis.
Typically, health FSAs are offered as a benefit under an employer’s cafeteria plan (or Section 125 plan) in order to allow employees to make their contributions on a pre-tax basis. Amounts in the health FSA can be withdrawn to reimburse employees’ eligible medical expenses that are not reimbursable by another source.
Health FSAs are subject to a number of federal employee benefit laws, including the following:
A health FSA is an employee welfare benefit plan under ERISA. Unless an employer is exempt from ERISA because it qualifies as a church or governmental employer, its health FSA must comply with ERISA’s standards. This means, for example, that the health FSA must have a plan document and summary plan description (SPD) and is subject to the Form 5500 annual filing requirement (unless a filing exception applies). ERISA-covered health FSAs are also subject to ERISA’s fiduciary duty standards and claims procedures requirements.
Health FSAs are group health plans that are subject to COBRA, unless the employer sponsoring the plan is a small employer (with fewer than 20 employees) or a church. Employers with health FSAs that are subject to COBRA should make sure that they are providing the required COBRA notices and are offering COBRA coverage to participants who would lose health FSA coverage due to a qualifying event.
Keep in mind that there is a special rule that applies to most health FSAs. Under this special rule, a health FSA sponsor:
Is not required to offer COBRA coverage to qualified beneficiaries who have “overspent” their health FSA accounts; and
Must offer COBRA coverage to qualified beneficiaries who have “underspent” their health FSA accounts, but the COBRA coverage may terminate at the end of the year in which the qualifying event occurs.
Health FSAs are group health plans that are subject to HIPAA’s Privacy and Security Rules, unless they qualify for the exemption for small plans (with fewer than 50 participants) that are self-insured and self-administered.
Code Section 125
Health FSAs that are offered under a cafeteria plan must satisfy the Internal Revenue Code (Code) Section 125 rules for tax-advantaged benefits. Among other requirements, the Section 125 rules impose restrictions on the types of expenses that may be reimbursed under the health FSA and limit when participants can make changes to their contribution elections during a coverage period.
Code Section 105(h)
Health FSAs must comply with nondiscrimination rules for self-insured health plans under Code Section 105(h). Under these rules, a health FSA cannot discriminate in favor of highly compensated individuals in regards to eligibility to participate in the plan, and the benefits provided under the health FSA must not discriminate in favor of participants who are highly compensated individuals.
Affordable Care Act
As group health plans, health FSAs are subject to certain reforms under the Affordable Care Act (ACA). For example, the ACA imposes a limit on employees’ pre-tax contributions to a health FSA and requires most health FSAs to qualify as “excepted benefits” to satisfy the ACA’s market reforms. In general, health FSAs must satisfy the availability AND maximum benefit requirements to qualify as excepted benefits.
Availability: Other non-excepted group health plan coverage (for example, coverage under a major medical group health plan) must be made available to health FSA participants.
Maximum Annual Benefit: The maximum annual benefit payable to the employee under the health care FSA cannot exceed two times the employee’s salary reduction under the health care FSA for that year (or, if greater, the amount of the employee’s salary reduction election plus $500).
The ACA limits employees’ pre-tax health FSA contributions to $2,500 per year (as adjusted for inflation). The adjusted limit for 2022 plan years is $2,850. The adjusted limit for 2023 plan years has not been released yet.
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.
Retiree-only health FSAs and health FSAs that only provide limited-scope dental or vision benefits qualify as excepted benefits under the ACA based on their design, and do not have to satisfy the availability and maximum benefit requirements.
As a general rule, an employer may allow any common law employee to participate in its health FSA. It may also impose a waiting period before new employees are allowed to participate. However, to qualify as an excepted benefit, a health FSA must generally meet the availability requirement described above. To satisfy this requirement, only employees who are eligible to participate in the employer’s group medical plan should be eligible for the health FSA.
Also, individuals who are not considered employees, such as self-employed individuals, partners in a partnership and more-than-2 percent shareholders in a Subchapter S corporation cannot participate in a Section 125 plan.
In addition, the nondiscrimination rules of Code Section 105(h) should be taken into account when designing a health FSA’s eligibility rules. Code Section 105(h) prohibits self-insured health plans (including health FSAs) from discriminating in favor of highly compensated individuals with respect to eligibility or benefits.
Use or Lose Rule: Employees must use their health FSA funds during the coverage period or they forfeit them. Exceptions apply for health FSAs with a grace period or carryover.
Uniform Coverage Rule: An employee’s maximum reimbursement amount must be available from the beginning of the plan year, even if it exceeds the employee’s current contributions.
Links and Resources
IRS Notice 2012-40 includes rules on the health FSA contribution limit
IRS Notice 2013-71 provides guidance on health FSA carryovers
The CARES Act allows health FSAs to reimburse over-the-counter drugs (OTC) and menstrual care products
IRS Notice 2020-29 relaxes the mid-year election change rules for 2020
IRS Notice 2020-33 increases the health FSA carryover limit for inflation