CARL WATTS & ASSOCIATES

November 23, 2015

www.carlwatts.com
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You may be a veteran of the Flexible Spending Account, or just contemplating to contribute to one for next year, either way you can find here all you need to know for next year’s FSAs.

The Health Care FSA is a Section 125 cafeteria plan which provides you with a way to use tax-free dollars to pay medical expenses not covered by other health plans, like co-payments for doctor visits, some uncovered services such as dental care or eye care expenses, and prescriptions.

Because eligible employees need to decide how much to contribute through payroll deductions before the plan year begins, many employers at this time of year are offering their employees the option to participate for the 2016 plan year.

Interested employees wishing to contribute must make this choice again for 2016, even if they contributed in 2015 (also, please note that self-employed individuals are not eligible). If you are one of these and haven’t contributed before, you should first check with your employer to see if they offer any FSAs, as employers are not required by law to accommodate such plans.

If you choose to participate, you can contribute up to $2,550 during the 2016 plan year (the same as in 2015, but up $50 compared to previous years). Amounts contributed are not subject to federal income tax, Social Security tax or Medicare tax.

The limit does not impact contributions under other employer-provided coverage. For example, employee salary reduction contributions to an FSA for dependent care assistance or adoption care assistance are not affected by the $2,550 health FSA limit.


The health FSA limit applies on an employee-by-employee basis. Each employee may elect to contribute from $50 only up to $2,550 in salary reductions, regardless of whether or not they also have family members who benefit from the funds in that FSA. However, each family member who is eligible to participate in his or her own health FSA will have a separate limit. For example, if you and your spouse have each your own health FSAs, you can both make salary reductions up to $2,550 per year (subject to any lower employer limits).

If you are an employee who participates in multiple cafeteria plans that are maintained by employers under common control, your total health FSA salary reduction contributions under all of the cafeteria plans are limited to $2,550.


However, if you have health FSAs through two or more unrelated employers, you can make salary reductions up to $2,550 under each employer's health FSA.

The limit does not apply to salary reduction contributions to a cafeteria plan that are used to pay for an employee’s share of health coverage premiums, to contributions to a health savings account (HSA) or to amounts made available by an employer under a health reimbursement arrangement (HRA).

Throughout the year, you can then use funds to pay qualified medical expenses not covered by your health plan, including co-pays, deductibles and a variety of medical products and services ranging from dental and vision care to eyeglasses and hearing aids. You should check with your employer for details on eligible expenses and claim procedures.

Generally, distributions from a health FSA must be paid only to reimburse you for qualified medical expenses you incurred during the period of coverage. You must be able to receive the maximum amount of reimbursement (the amount you have elected to contribute for the year) at any time during the coverage period, regardless of the amount you have actually contributed. The maximum amount you can receive tax free is the total amount you elected to contribute to the health FSA for the year.


You must provide the health FSA with a written statement from an independent third party stating that the medical expense has been incurred and the amount of the expense. You must also provide a written statement that the expense has not been paid or reimbursed under any other health plan coverage. The FSA cannot make advance reimbursements of future or projected expenses.


Qualified medical expenses are those specified in the plan that would generally qualify for the medical and dental expenses deduction.

Also, non-prescription medicines (other than insulin) are not considered qualified medical expenses for FSA purposes. A medicine or drug will be a qualified medical expense for FSA purposes only if the medicine or drug:

  • Requires a prescription,
  • Is available without a prescription (an over-the-counter medicine or drug) and you get a prescription for it, or
  • Is insulin.
Your Health Flexible Spending
Account for 2016

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Compliance relief is provided for certain salary reduction contributions exceeding the $2,550 limit that are due to a reasonable mistake and not willful neglect and that are corrected by the employer. More specifically, if one or more employees are mistakenly allowed to elect a salary reduction of more than $2,550 for a plan year, the error may be corrected without causing the cafeteria plan to lose its preferential tax status if:

  • The plan’s terms apply uniformly to all participants;
  • The error results from a reasonable mistake by the employer (or its agent) and is not due to the employer’s (or agent’s) willful neglect; and
  • Salary reductions in excess of the $2,550 limit are paid to the employee and reported as wages for income tax withholding and employment tax purposes on the employee’s Form W-2.

Under the use or lose provision, participating employees often must incur eligible expenses by the end of the plan year, or forfeit any unspent amounts. But under a special rule, employers may, if they choose, offer participating employees more time through either the carryover option or the grace period option.

Under the grace period option, you have until 21/2 months after the end of the plan year to incur eligible expenses—for example, March 15, 2017, for a plan year ending on Dec. 31, 2016.


Under the carryover option, you can carry over up to $500 of unused funds to the following plan year—for example, an employee with $500 of unspent funds at the end of 2016 would still have those funds available to use in 2017. In a nutshell, the FSA carryover rules are the following:

  • The IRS has modified the rule requiring unused amounts to be forfeited, commonly referred to as the “use-or-lose” rule, by allowing carryover of up to $500 from one plan year to the next plan year;
  • Any unused amount in excess of $500 at the end of the plan year is forfeited;
  • An employer must amend its §125 cafeteria plan document no later than the last day of the plan year from which it wants to carry over the amount.;
  • A cafeteria plan adopting the carryover provision is not permitted to provide a grace period, which generally allowed payment for expenses incurred within 2 ½ months of the end of the plan year with respect to health FSAs;
  • Cafeteria plans must be amended to adopt the carryover provision and remove the grace period rule, if applicable;
  • Amendments to adopt the carryover provision generally must be adopted on or before the last day of the plan year from which amounts may be carried over;
  • An employer may limit the carryover amount to less than $500 or decide not to allow a carryover at all;
  • The carryover amount is available, even if a participant does not make an election for the next plan year. For example, if $500 remains unused at the end of the plan year, it can be carried over for the next plan year even though the participant does not elect Health FSA coverage in the following year. The participant will start the new plan year with a $500 account balance. In theory, this balance could be carried over for several years even though the participant does not elect Health FSA coverage;
  • A Health FSA still cannot allow a cash-out of unused amounts or a transfer of unused amounts to other taxable or nontaxable benefits. Health FSAs can still use run-out periods.


The carryover provision does not apply to Dependent Care FSAs. HRAs have had the carryover option since their 2002 inception.

We will keep you informed and up-to-date with any new IRS rules and regulations with an impact on your taxes and finances for the current and the upcoming year. So, please check out our newsletters regularly.