Under the use-it-or-lose-it rule, unused flexible spending account (FSA) balances can be forfeited back to employers. They then have several options for handling the money. Here is what small business owners, as employers, need to know after first covering some necessary background information.
Flexible Spending Account Basics
Under an employer-sponsored FSA plan, employees can contribute a designated amount of their annual salary to their personal health care FSA or dependent-care FSA or both.
For a health care FSA, the maximum amount that an employee can contribute for the 2017 tax year is $2,600, and for a dependent-care FSA, the maximum amount that can be contributed is $5,000 for 2017 for married and filing jointly. For a married employee, the $5,000 cap represents the maximum amount that both spouses can together contribute.
FSA contribution amounts are withheld in installments from employee paychecks. The FSA money is then used to cover eligible out-of-pocket medical and dependent-care expenses. The amounts withheld from employee paychecks are treated as a salary reduction for tax purposes, and reimbursements from FSAs to cover qualified out-of-pocket expenses are tax-free to employees.
In other words, the FSA arrangement allows participating employees to pay for some or all of their out-of-pocket medical expenses and dependent care expenses with pretax dollars. That is the same as getting an income tax deduction combined with a reduction in Social Security and Medicare tax withholding.
The Use-It-Or-Lose-It Rule
For employees, the main drawback to an FSA is the use-it-or-lose-it rule. If the employee doesn’t spend all their FSA money, it usually reverts back to the employer. However, there are two exceptions to the rule.
- An FSA plan can allow a grace period of up to 2 1/2 months. For a calendar-year FSA plan, that gives employees up to March 15 of the following year to use all the money from the previous year.
- A health care FSA plan can allow employees to carry over up to $500 of unused balances from one year to the next. Keep in mind, though, that a health care FSA plan can offer either the carryover privilege or the grace-period deal, but not both.
- Dependent-care FSAs cannot allow the carryover privilege, but they can allow the grace period.
Employer Options for Forfeited FSA Balances
According to the IRS, employers can do one of two things with unused employee FSA balances:
- The employer can simply keep the money.
- If the employer doesn’t keep the money, it must be used for the following:
- To defray expenses of administering the cafeteria benefit plan under which the FSA program or programs are offered.
- To reduce employee FSA employee contributions for the immediately following FSA plan year.
- Returned to the employee on a reasonable and uniform basis.
For more information about FSAs and employer responsibilities, contact Filler & Associates.