What Employers and Employees Must Know about the Use-it-or-Lose-it Rules of FSAs by Steven Rubin, CPA
Posted on June 06, 2023
by
Steven Rubin
Whether you are an employer or employee, you recognize the benefits of Flexible Spending Accounts (FSAs) to help pay for rising costs of out-of-pocket healthcare expenses. Nevertheless, how unused account balances are treated at the end of the plan year is often misunderstood and can be a source of pain for both employees and employers.
A health FSA is an employer-sponsored benefit plan that allows employees to voluntarily set aside pre-tax dollars from their salaries to pay for qualifying medical, dental, vision and mental health expenses not covered by medical and dental insurance. Qualifying expenses may include the following:
- prescription medicines
- over-the-counter cold, allergy, flu and pain-management medication
- bandages and first-aid supplies
- crutches and splints
- sunscreen
- menstrual-care products
- pregnancy tests, prenatal vitamins and baby-care products
- prescription glasses and contacts
- smoking-cessations programs
- weight-loss programs
- insurance co-pays and deductibles
The money employees agree to defer from their salaries to fund their FSAs is deducted from their gross income along with any employer contributions and can help to reduce employees’ federal income tax liabilities. Similarly, because employees use pre-tax dollars for their FSA contributions, employers are not responsible for paying Medicare and Social Security taxes on those amounts.
The maximum amount an employee may contribute to an FSA is set by federal law and adjusted annually for inflation. For 2023, the cap is $3,050. Plan participants should save receipts of FSA-covered expenses and keep track of their account balances to ensure they use all their funds by the plan’s year-end or risk falling victim to the “use-it-or-lose-it” rules.
When employees’ FSAs have balances remaining in their accounts after the end of a plan year, employers may choose to 1) allow plan participants to roll over unused balances into the subsequent year or 2) grant a grace period for participants to use a limited amount of remaining savings within 2½ months of the new plan year. Alternatively, the IRS allows employers to keep the money and use it for one of the following approved purposes: 1) to pay the plan’s administrative expenses, 2) to make employer contributions to all employees’ FSAs, 3) to reduce all employees’ FSA contributions for the following year, or 4) to refund the money to all employees who then must treat those amounts as taxable income.
Employers should have a system in place for reminding FSA participants to use their accumulated savings during each plan year. At the same time, employees with significant FSA balances at the end of the third quarter should consider stocking up on qualifying supplies, refilling expiring prescriptions, making needed and often neglected doctors’ appointments or scheduling important procedures they were holding off on until the following year.
About the Author: Steven Rubin, CPA, is a senior manager of Tax Services with Berkowitz Pollack Brant Advisors and CPA, where he provides federal, state and local tax compliance and consulting services to corporations, closely held businesses and high-net-worth families. He can be reached at the CPA firm’s Ft. Lauderdale, Fla., office at (954) 712-7000 or info@bpbpcpa.com.
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