Flexible Spending Accounts FAQ

Q: How can an employer offer its employees tax savings for eligible health and dependent care expenses?
A: An employer can set up a flexible spending plan that allows flexible spending accounts (FSAs) for health care, dependent care or both. This makes it possible for employees to pay eligible expenses with tax-free dollars. An FSA must be established in writing. Contact MMBB at service@mmbb.org for a free FSA sample kit.

Q: How does an FSA work?
A: When an employer establishes an FSA, employees can each year elect how much to set aside from their paychecks for the following year. Paychecks throughout the year are reduced accordingly. Money withheld from each paycheck is not reported as taxable income for federal income tax or Social Security/Medicare tax. In most states, FSA contributions are not reported for state income tax purposes either. (See Federal Reporting Requirements for Churches by Richard R. Hammar.)

The health care FSA is used only for eligible health care expenses and the dependent care FSA is used only for eligible dependent care expenses. An employee cannot have money transferred from the health care FSA to the dependent care FSA or vice versa. The church sets the annual health care contribution limit at whatever they deem appropriate. The IRS has set the maximum dependent care reimbursement amount at $5,000 per year. When the employee incurs an eligible expense, he or she submits documentation to the employer and is reimbursed with tax-free funds.

An annual election cannot be changed during the year unless the employee has a change in family or employment status that meets IRS requirements, such as marriage or birth of a child. Under IRS rules, any money for the year that is not claimed by the claims filing deadline in the following year is forfeited and returned to the employer. Unspent amounts cannot be carried over from year to year unless the employer amends the plan to include the IRS grace period. Beginning in 2011, during the grace period, expenses for qualified benefits (except for over-the-counter medication purchased without a prescription) incurred by plan participants may be paid or reimbursed from contributions remaining unused at the end of the preceding plan year.

The maximum grace period can only extend through the 15th day of the third calendar month after the end of the immediately preceding plan year.

Q: What types of expenses can be reimbursed under an FSA?
A: Health care FSA money can be used for health care expenses that are not reimbursed by a health care plan, such as deductibles, co-payments and items that are not covered, such as dental, vision and hearing expenses.
In the past, over-the-counter medication could be claimed as an eligible expense under a health care FSA if the employer’s FSA document and employee communication indicated that these expenses could be claimed. As a result of the new healthcare legislation, over-the-counter medication is not eligible for FSA reimbursement after December 31, 2010 unless the purchase is pursuant to a doctor’s prescription.

Dependent care FSA money can be used for child care expenses incurred for children under the age of 13, such as nursery school tuition and day care fees. It may also be used for the care of disabled adults who have the same principal residence as the taxpayer for more than half of the taxable year.

Q: Should the church report FSA contributions on the employees’ IRS Form W-2?
A: No.

From the 2012 MMBB Guide for Church-Related Employers. For the full guide, please visit our Download Documents & Resources section.