FSA rules and requirements
These tax-advantaged accounts can be an extremely valuable benefit to your employees. However, there are rules and regulations you must follow to stay compliant.
If an employer offers an FSA alongside a cafeteria plan, it’s subject to IRS Code Section 125. However, if you don’t offer an FSA through a cafeteria plan, it’s subject to Section 105 instead.
Employer contributions
If an employer decides to contribute to an employee's healthcare FSA, the IRS allows an employer match separate from employee contribution limits. An employer can contribute up to $500 to a healthcare FSA, no matter if the employee contributes. Starting at $501, employers can only match dollar-for-dollar contributions.
Employers can also limit how much they want to contribute to an FSA. For example, suppose an employee contributes $1,000 to a healthcare FSA. In that case, an employer can decide to either match that and contribute $1,000 or cap contributions at any dollar amount they choose, such as $500.
You must include employer contributions to long-term care insurance through an FSA in an employee's income.
Employee contributions
Employees contribute to their FSA by electing to have money voluntarily withheld from their pay through a salary reduction agreement. Employees don't pay federal income tax or employment taxes on their contributions.
Your employees can choose their contribution amounts at the beginning of the plan year. Then, you can deduct the amounts periodically by the annual election. Employees can change or revoke elections only if there's a change in employment or family status specified by the plan or during your benefit's open enrollment.
Distributions
Employers reimburse employees for qualifying expenses incurred during the plan year. Employees are eligible for the maximum reimbursem*nt under your plan at any time during the plan year, regardless of how much you or your employee contributed. These distributions aren't counted as taxable income for payroll taxes or federal taxes.
You can't reimburse employees for health insurance premiums, long-term care coverage, or any medical expenses covered under another plan, such as health insurance or an HRA.
Any reimbursem*nts made for non-qualifying expenses count as taxable income.
A third-party administrator must substantiate all FSA expenses. An FSA debit card is also a popular feature for automatically substantiating purchases.
Grace period and carryover funds
Employers can allow unused healthcare FSA funds to carry over into the following year. The IRS caps the carryover for unused funds at $640 for 2024. If employers choose not to have a carryover balance, they can set up a two-and-a-half-month grace period for employees to use their remaining FSA funds.
However, employees can't choose to have both a grace period and a carryover balance. They must choose one or the other, or neither.
Tax reporting
Unlike HSAs, employees don't need to report FSAs to the IRS on their income tax returns. You also don't need to report FSAs on Form 1040.
Non-discrimination testing
FSAs, like other employee benefits, are subject to non-discrimination testing. This allows you to show that your benefits plan complies with federal non-discrimination laws for highly compensated employees, officers, and owners.
ERISA requirements
Since an FSA falls under ERISA, employers must file Form 5500 with the IRS to report their plan information each year. You'll also need to offer COBRA for qualified employees.
All FSAs must have plan documents and provide employees with a summary plan description (SPD).
