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Healthcare Flexible Spending Account Rules

Heath care benefits are one of the most important perks that employers offer to employees. The cost of health insurance premiums, co-pays, co-insurance and other costs can amount to thousands of dollars a year, but many employers subsidize the cost of health care for their employees. Some employers offer flexible spending accounts, FSAs, to employees, which allows workers to save money for health care cost on a tax-advantaged basis.

  1. FSA Basics

    • An FSA is a special account that employees can contribute money toward on a pre-tax basis and spend on medical expenses tax free. Similar to a 401k plan, an employee typically elects to contribute a certain amount of his salary to his FSA each year, which is automatically deducted from pre-tax income. Employers may also contribute to FSAs on behalf of employees. An employee loses any funds in an FSA that is unspent at the end of the plan's calendar year. FSA funds do not rollover from one year to the next.

    Qualifying Expenses

    • FSA funds may only be used to pay for qualifying medical expenses. According to the IRS, expenses that qualify as tax deductions for medical and dental expenses also qualify as reimbursable medical expenses for FSAs. Qualifying expenses include: costs related to abortion, ambulance service, X-rays, medicines, surgery, drugs and laboratory fees. IRS Publication 502 contains a full list of expenses that qualify as deductible medical expenses.

    Over-the-counter Drugs

    • Medical legislation, passed in 2010, changes the way FSAs interact with over-the-counter medications. According to the IRS, the cost of over-the-counter medicine or drugs cannot be reimbursed with an FSA unless you have a prescription for the medication. This change went into effect on January 1, 2011. The IRS also states that the changes do not apply to insulin, medical devices like eyeglasses or contact lenses or common medical expenses like co-pays and deductibles.

    Pros and Cons

    • Flexible spending accounts can be advantageous to employees by eliminating taxes on money spent on health care. For example, if you know you are going to pay for a $1,000 medical procedure, you could contribute $1,000 to your FSA and avoid taxation on the $1,000. The primary drawback of FSAs is that funds do not carry over from one year to the next, so contributing too much can result in waste. If you contributed $1,000 to an FSA but had only $500 in medical expenses during the year, you would lose the remaining $500. FSAs force employees to estimate how much medical care they will use during a year and contribute accordingly to avoid waste.

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