Know the Rules: Understanding the IRS Regulations for FSAs

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Flexible Spending Accounts (FSAs) make healthcare more affordable for employees by allowing them to contribute an annual amount based on the amount they expect to spend for healthcare expenses not reimbursed by their insurance. The account is funded with paycheck deductions that are taken before any taxes are calculated. That’s where the savings come in. Employees don’t pay taxes on the money they contribute to their FSA account, saving them hundreds of dollars every year.

While an FSA is a great solution that helps employees save on healthcare expenses not covered by their insurance, FSAs must meet certain rules and regulations set by the Internal Revenue Services (IRS). FSAs are an IRS-regulated benefit because reimbursements from an FSA that are used to pay qualified medical expenses are not taxed. Additionally, contribution limits and updates like the update to the “Use It Or Lose It Rule” are also set by the IRS. For these reasons, it is important for employers to understand IRS regulations surrounding FSAs. Failure to comply with these regulations can result in costly penalties and fines for the employer. To help avoid noncompliance, we highlight some of these regulations to ensure proper compliance with the IRS for FSAs.

What IRS regulations should I be aware of for FSAs?

Healthcare FSAs are governed by Internal Revenue Code Section 125 when offered through a cafeteria plan. A cafeteria plan is a written plan that offers employees a choice between receiving their compensation in cash or as part of an employee benefit. If the healthcare FSA isn’t offered through a cafeteria plan, it’s subject to Internal Revenue Code Section 105, which allows employers to establish a written plan to reimburse medical expenses for employees. These plans are usually subject to ERISA, COBRA and HIPAA laws.

Can an FSA be offered with any health plan?

Yes. An FSA plan can be offered alongside any medical or dental plan. However, it’s important to note that employees can only enroll in a limited-purpose FSA if they also contribute to an HSA according to IRS regulations.

Can employees change their FSA contribution amount?

Due to IRS regulations, enrollment and contribution amounts remain in effect for the plan year, unless there is a qualifying family status change, such as a marriage, birth or death of a dependent.

Can owners or partners participate in an FSA?

No. According to IRS guidelines, anyone with two percent or more ownership in a schedule S corporation, LLC, LLP, PC, sole proprietorship, or partnership may not participate. However, C-corporation owners and their families are eligible to participate in FSA plans because they are considered to be W-2 common law employees.

Do non-discrimination rules apply?

Yes. Based on requirements set by the IRS Section 125 Cafeteria, Flexible Spending Accounts cannot discriminate in favor of highly compensated or key employees. To meet compliance with IRS regulations, non-discrimination tests are conducted as a way to demonstrate fairness in benefit plans among all levels of employees at a business. Many of these tests involve eligibility by examining who can participate, the benefits offered and contributions, and utilization, which looks at who uses the benefits and to what extent. 

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We understand employee benefits can be confusing–especially when it comes to compliance with IRS rules and regulations. At Clarity, our team of experts is ready to help you today and in the future by anticipating your needs, providing exceptional customer service and consistently looking for new ways to innovate and make your benefits better. If you have any questions about compliance, please contact us today.