What is a Flexible Spending Account (FSA)?

Businesses are nothing without strong employees. One proven way to attract and retain top talent is by offering a strong benefits package. As part of a health plan package, many businesses consider offering a FSA. Let’s take a look at what a FSA is.

What is a FSA?

A FSA, or flexible spending account, is a type of savings account in which an employee contributes a specific amount of their earnings into for use towards certain healthcare costs throughout the year. Employers, although not required to, can also contribute to the plan. There are two types of flexible spending accounts and they are as follows:

• One type of account is used for health expenses
• The other type of account is used for dependent and child care expenses

Employers can set the contribution limits of the plan, but the amount can not exceed the IRS limits. The IRS limits on a FSA for 2022 are as follows:

• $2,850 for health expenses
• $5,000 for dependent or child care expenses

What can a FSA be used for?

As previously stated, any contributions made to a FSA can be used for either health and medical expenses or dependent and child care. Distributions from the plan can be made for qualified medical expenses to the following:

• You and your spouse.
• All dependents you claim on your tax return.
• Any person you could have claimed as a dependent on your return except that:
  1. The person filed a joint return;
  2. The person had gross income of $4,300 or more; or
  3. You, or your spouse if filing jointly, could be claimed as a dependent on someone else’s 2021 return.
• Your child under age 27 at the end of your tax year.

The IRS has specific guidelines for which expenses qualify. Some of the more common examples are:

• Deductibles
• Copayments
• Prescription medication
• Vision care
• Thermometers
• First-aid kits
• Hearing aids
• Crutches
• Mental health counseling
• Addiction treatment
• Certain over-the-counter medications
• Chiropractor care
• Birth control
• Other health care related items/services

What are the benefits of a FSA?

In regards to a FSA, there are benefits for both employees and employers.

For Employees

First, contributing to a flexible spending account results in a tax savings for employees. The contributions to a FSA are taken out of an employee’s gross wages on a pretax basis, which lowers the employee’s taxable wages. Since the taxable wages are lowered, the amount of income and payroll taxes that an employee pays is also lowered.

Secondly, funds in the plan are reimbursed to the employee to pay for qualified medical expenses. Those employees that have high medical costs each year would benefit as they have been saving throughout the year to help pay for those bills. Should there be enough saved in the plan, there would be no need for the employee to come up with large out-of-pocket payments. Additionally, when the funds are withdrawn to pay for the medical expenses, no taxes are taken from the funds.

For Employers

First, offering a FSA plan as part of your benefits package can help attract and retain talent for their business. Certain applicants that have high medical expenses look for job opportunities that offer FSA plans. Additionally, employers can elect to contribute to employee plans to increase the total amount in the plan. Remember, the 2022 limit for FSA plans are $2,850 for health plans and $5,000 for dependent or child care plans. These limits are only for employee and spouse contributions, meaning if an employer decides to contribute, then the plan amount can exceed these limits. This is especially beneficial to those employees that expect to have high medical costs throughout the year.

Secondly, since the employee’s contributions to the plan are on a pretax basis, the employers tax liability is lowered. Employers must match the amount that employers pay for FICA taxes. When employees pay less FICA taxes, employers in turn pay less FICA taxes.

Finally, any administrative costs associated with a FSA can be written off by the employer. Consequently, this also lowers an employers tax liability.

What are the cons of these plans?

The biggest disadvantage of one of these plans is that if all of the funds in the plan are not used by year end, the money in the plan is forfeited by the employee. When this happens, there are two options for businesses to offer their employees. Employers can put a policy in place that offers a grace period for employees to use the funds before they lose them. However, according to the IRS, this grace period can not exceed two and a half months. The other option is called a FSA rollover. In this scenario, employees can rollover up to certain amount to the following year. The 2022 rollover limit is $570. Any funds remaining after the grace period is over, or over the $570 rollover maximum is forfeited.

Another negative of a FSA is that it is not a savings account that the employee owns. Should an employee leave the company mid-year, they can not take those funds with them. These funds are forfeited by the employee upon separation.

How do employers start a plan?

The best way for employers to start a plan is by working with a third party administrator. While businesses may choose to run their own plan, ensuring tracking requirements, compliance and employee confidentiality is easier with a plan administrator. Furthermore, we recommend working with a trusted payroll vendor. This allows employee and employer contributions to the plan be setup and taxed properly. Please contact us if you need additional help with flexible spending accounts for your business.