What is a Flexible Spending Account?

A Flexible Spending Account also known as an FSA, a Flex Plan or a Cafeteria Plan is an employee benefits plan regulated by Section 125 of the Internal Revenue Code that can be customized and combined to meet the benefit needs of any company and its employees. The use of Flexible Spending Accounts in a Cafeteria Program, give a unique opportunity to the employee to reduce taxable income while paying for necessary health care and dependent care expenses and also offer substantial tax savings to the employer as FSA contributions are sheltered from FICA, Medicare, federal income and unemployment taxes, as well as state income and unemployment taxes in specific states.

How does a Flexible Spending Account Work?

The spending account concept is a simple one. Through flexible spending accounts, the employee is reimbursed with "before-tax" dollars -- dollars that are set aside from each paycheck before federal income taxes and Social Security taxes are withheld -- for certain expenses that are incurred. Since taxable income is less, the amount of income taxes withheld also is less. There are three (3) types of flexible spending accounts:

1. A Premium Conversion Account. The Premium Conversion Account allows use of tax free dollars to pay for insured premiums.
2. A Health Care Spending Account. The Health Care Account allows use of tax-free dollars to pay for a wide range of health-related expenses that are not paid by health plans - including medical, dental and prescription drug and some over the counter health expenses for the employee and eligible dependents. In addition, there are other health care expenses considered eligible under Internal Revenue Service guidelines. Publication 502 from a local IRS office or through the Internet at www.irs.com, lists further information on health care expenses that are eligible for reimbursement from a Health Care Spending Account.
3. A Dependent Care Spending Account. The Dependent Care Spending Account provides tax-free reimbursement of eligible dependent day care expenses that are incurred in order to work.

The amounts withheld from participants' paychecks are deposited into a dedicated checking account. Amounts must be tracked carefully, as each participant is entitled to expense reimbursements equal to the amount being withheld. FSA's are tracked in 12 month periods called Plan Years. Participants define the amount they want to contribute during the Plan Year. The elected amount is withheld equally from each paycheck during the year. As expenses are incurred, the participant submits proof of the expense and is then reimbursed from the FSA checking account.

Expenses are considered "incurred" when the service is performed, not when it is paid for. Payments are issued and mailed to participants on the day a claim is received. Participants are reimbursed up to the full amount of their annual election for expenses eligible under the Health Care Spending Account. Participants are only reimbursed from the Dependent Care Spending Account to the extent that there are sufficient funds in the Account to cover the request.

Can an Election Be Changed During The Plan Year?

The amount of the annual election can only be changed in the event of a "Change in Family Status", which is defined as:

• Change in marital status or divorced.
• Birth or adoption of a child.
• Death of a dependent.

What Happens to Moneys Left At The End Of The Plan Year?

Any moneys left at the end of the Plan Year will be forfeited. This unclaimed money at the end of the grace period can be used for:

• To defray plan administrative costs.
• Donated to a charity.
• As equally distributed refunds to all participating employees.

What are the Important Things To Remember?

• Participants must make benefit elections prior to the beginning of each plan year and must specify an amount to be deposited to the account. The employer determines the Plan year.
• Benefit elections may not be changed after the plan year begins unless there is a change in family status. Family status changes include the birth, death or adoption of a child, marriage, divorce, termination of spouse's employment, etc.
• If there are expenses in a specific account (i.e. medical reimbursement or dependent care), which exceed the amount set aside, the participant may not be reimbursed for the excess. If the entire amount set aside in a specific account is not used by the end of the year, this amount, by law, reverts back to the employer. This is the so-called "use it or lose it" provisions established by the Internal Revenue Service.
• Money from the different accounts cannot be commingled. This means that election for dependent care can only be used for dependent care expenses and election for medical reimbursement can only be used for medical reimbursement.
• The participant may be reimbursed only for expenses, which are incurred during the plan year. For example, if the plan year runs from January 1st to December 31st, charges can only be submitted if incurred in that time period.
• In addition to the above IRS provisions, it is important to note that Voluntary Salary Conversions could slightly reduce potential social security benefits for retirement or disability. Benefits from Flexible Spending Accounts are higher than what Social Security will provide (in most cases).

What About Reporting and Disclosure?

If the benefits provided under a cafeteria plan satisfy the requirements for income tax exclusion under both Section 125 of the tax code and the tax code sections that provide the tax exclusions for each benefit, they are not subject to federal income tax withholding, social Security (FICA) taxes or federal unemployment (FUTA) taxes. There are three exceptions to this rule:

• Contributions to any Section 401(k) qualified retirement plan that is included in a cafeteria plan are subject to FICA taxes, despite its inclusion in a cafeteria plan.
• Premiums on group term life insurance protection in excess of $50,000 are subject to income taxes (but not withholding on such taxes) and FUTA taxes.
• After-tax benefits available under the plan are subject to income, FICA and FUTA taxes, as applicable.

Currently, all states impose unemployment taxes (SUTA) on flex plan contributions except the following: Arizona, California, Colorado, Georgia, and Idaho. Indiana, Nebraska, North Carolina, Ohio, South Carolina, Utah, Virginia and Wisconsin.

Why Offer a Flexible Spending Account?

• A Flexible Spending Account reduces employment taxes.
• A Flexible Spending Account is an added benefit to participants without adding additional costs to employers.
• A Flexible Spending Account reduces participant's taxable income.
• A Flexible Spending Account increases participant's spendable income.
• A Flexible Spending Account offers the purchase of other benefits by the participant on a pre-tax basis.
• A Flexible Spending Account offers benefit selections based upon need.

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