So some of your employees have a flexible spending accounts (FSA). They love using this tax-advantage plan to help manage out-of-pocket medical costs. But, what happens if they have money left in their FSA account by the time year-end rolls around? I tackle this question in my latest edition of Compliance Corner.
Q. Some employees had some leftover money in their FSA at the end of the year. Can I give those employees back their unused withholdings as taxable income?
A. No. You can’t return an individual’s withholdings to them if they have leftover money in their FSA at the end of the plan year.
A health FSA will have leftover money, or experience gains, if salary withholdings along with employer contributions exceed health FSA reimbursement for that plan year. These experience gains are also called forfeitures because they’re the result of participants forfeit unused FSA balances under the use-or-lose rule.
Health FSA forfeitures will be subject to a number of rules under both the tax code as well as ERISA. But, under those rules there are four permissible uses. The plan document will control what you are allowed to choose from among these options, so check your plan document first:
- A plan sponsor may use forfeitures to pay for that plan’s reasonable administrative expenses. It must be the FSA. The FSA forfeitures can’t pay for the costs of any other plan, such as a Dependent Care Account (DCA). Forfeitures can’t pay for certain types of fees, such as the initial cost of setting up a plan (this type of fee is called a ‘settlor expense’).
- A plan sponsor can use the forfeitures to lower the salary reductions of participating employees; this is sometimes called a “premium holiday.” When a plan sponsor allocates the forfeiture among the employees, it must be done on a reasonable and uniform basis. That is, you can’t return money to individual employees based, directly or indirectly, on their claims experience. You can’t return the money based on the amounts forfeited by an individual employee. That would violate the use-or-lose rule.
- A plan sponsor can also use the forfeitures to increase the annual coverage amount. Again, the forfeitures must be allocated on a reasonable and uniform basis, under no circumstances should the allocation be based on individual claims experience. The plan document has to be reviewed carefully for this option because if there is a plan limit on benefits then some amendments may be required in order to take advantage of this option.
- The final option is a cash refund. It’s important to note that this is a cash refund to all employees on a reasonable and uniform basis as discussed in the other options and not a refund of money just to employees with underspent accounts.
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