or Medical Care
If your company doesn't provide health care insurance or
if you do provide coverage but you're faced with increasing
deductibles, co-pays or out-of-pocket expenses, there's no
time like the present for taking a look at flexible spending
There is no statutory limit
on medical FSA contributions, although employers often
impose restrictions. There is a $5,000 annual limit on
contributions to a dependent care FSA.
Announces Favorable New Rules
In a welcome
move for employers and employees, the IRS relaxed the
rules involved in tax-saving flexible spending accounts.
The tax agency announced in 2005 that employees may be
able to get an extra 2 1/2 months after year-end to
spend the money set aside in their accounts before they
lose it. (IRS Notice
In order to take
advantage of the grace period, however, employers must
amend FSA plans by December 31 to permit the extra 2 1/2
months — through March 15 of the following year (this
assumes the FSA plan operates on a calendar-year basis,
which is almost always the case). Employees can use any
unspent year-end balances to reimburse themselves for
qualified expenses incurred within the grace
to understand: The use-it-or-lose-it rule still
exists, but the grace period greatly softens the blow by
allowing employees more time to use their unspent FSA
A form of cafeteria plan under Section 125 of the Internal
Revenue Code, a health care FSA allows employees to set aside
pre-tax dollars from their paychecks to pay medical and dental
expenses that are not reimbursed from an insurance plan.
Eligible expenses are then reimbursed from the employee's
account. You can also offer flexible spending accounts for
dependent child or elder care expenses.
spending accounts offer several advantages to you company and
your employees. However, there are also some disadvantages to
be aware of. One of the best known is the "use it or lose it"
feature. Any amounts contributed to an account and not spent
by the end of the year are forfeited to the employer. However,
a 2005 IRS ruling softened this deadline considerably.
Employees now may have an additional 2 and 1/2 months after
the end of the plan year to spend FSA funds, if the employer
amends its plan by December 31st to allow for this extension.
(See the right-hand box for more on this subject.)
are some more pros and cons of flexible spending accounts for
your company and its employees:
From the Employer's Perspective
Decreased employee taxable income, as a
result of contributions to reimbursement accounts, results
in decreased expenditures for FICA, unemployment insurance,
workers' compensation and other wage-based
The cost for administration is typically
offset by the savings on payroll taxes.
Interest is earned on account
The primary area of concern for employers is
the "at risk" provision associated with health care
reimbursement accounts. The "at risk" provision requires
that you reimburse an employee for incurred eligible
expenses up to the full amount that he or she has elected to
set aside during the plan year — regardless of how much he
or she has actually contributed up to that point.
For example, let's say an employee has elected to
contribute $2,400 for the plan year and incurs $2,400 of
eligible expenses at the end of the second month. At this
point, the employee has only contributed $400 to his account,
yet he is entitled to $2,400 in reimbursement. If the employee
remains with your organization, he will contribute the
remaining $2,000 by year's end. However, he has no repayment
obligation if he leaves his job before the end of the year.
But there is a flip side. An employee who leaves in
the course of the year without having expended any or all of
what he has contributed to his account relinquishes the
remaining account balance, unless he continues participating
through COBRA. Employees also forfeit to their employers any
unspent amounts left in their accounts at the end of the
Apart from the offsetting savings, you can cap
your company's liability by limiting the amount that employees
set aside. Some employers use a two-tiered capitation:
Limiting first-year participants to $1,000, for example, while
they become accustomed to the program, and then capping future
participation at a higher amount, say $3,000.
From the Employee's Perspective
Reduced taxable income means employees reduce
their federal, FICA and, frequently, state taxes. Because an
FSA reduces adjusted gross income, it may make an employee
eligible for other valuable tax benefits.
Employees can be reimbursed with pre-tax
dollars for out-of-pocket deductibles, co-pays and
procedures that are not covered by their health care
insurance (if they have coverage).
For many taxpayers, FSAs are the only way to
get a tax break for medical expenses. That's because medical
expenses are only deductible to the extent they exceed 7.5
percent of adjusted gross income.
Contributing pre-tax dollars to their FSAs
provides employees with more spendable
Employees are concerned about the "use or
lose it" provision of health care accounts. If an employee
elects to contribute $2,400 for the plan year, but incurs
only $2,000 of eligible expenses, the remaining $400 reverts
to the employer. However, planning and past experience can
result in accurate contribution-estimates. And the savings
on taxes may offset any loss.
While the "use it or lose it" provision applies to
dependent care accounts as well, there is generally less risk.
Employees find it easier to estimate what they will spend for
child or elder care on an annual basis.
If you are interested in learning more about flexible
spending or reimbursement accounts, call Ronald J.Cappuccio,
J.D., LL.M.(Tax) at (856) 665-2121. Keep in mind that if you
decide to implement an FSA plan, employee education is a
critical component for maximum participation.