Things You Need To Understand about a Flexible Spending Account

Does My Company Qualify?

Virtually any company can save money on taxes by sponsoring an FSA plan. This includes C-Corporations, S-Corporations, Partnerships, Limited Liability Companies (LLCs), Limited Liability Partnerships (LLPs), Sole Proprietorships, Professional Associations, and Not-For-Profits.

In some cases, participation in the plan is limited:

  1. Shareholders who own more than 2% of an S-Corporation may not participate in cafeteria plans. Family members and close relatives of those shareholders also are excluded. However, the company may still sponsor cafeteria plans for their other employees.
  2. Members of an LLC, LLP and Sole Proprietors also are excluded from participation in a cafeteria plan, but may sponsor one for their employees. However, unlike an S-corporation, if the spouse is a bona fide employee of the firm, he or she may participate and use the benefit for the entire family.

There are no limitations on owners of a C-corporation. They may both sponsor and participate in a cafeteria plan.

When can I start my plan?

Ideally, your FSA plan should renew each year along with your other group benefits. However, there’s no need to wait to get started. Your first plan year can be a short year, so it can start whenever you want to take advantage of the savings and flexibility offered by an FSA. Allow at least a month to be sure you have time to educate employees and have them enroll before the plan begins.

What Do I need to Understand about Flexible Spending Accounts?

Employees must make their elections before the plan year begins and they can’t be changed or ended at any time during the plan year unless the participant has a change of status, or the required contributions to pay premiums for the elected benefits change significantly during the plan year.

Because social security tax is not paid on income reductions made to the plan, social security benefits may be reduced slightly. This is usually negligible and more than offset by the tax savings derived from the plan.

Uniform Coverage Rule

This rule simply says that the annual contribution elected by the employee for his or her MedFlex Account must be available to the employee from the first day of the plan. For example, if the employee has elected $1200.00 per year and has a $500 claim in the first month of the plan year, the claim must be paid in full, even though the money may not be fully payroll deducted from the employee for several months. This risk is also not as great at it may seem:

  • All payroll deductions for employer cafeteria plans are maintained by the employer in a general employer account. FlexRight notifies the employer of the amount of any claims prior to debiting the account. Only actual claim amounts are then deducted. All remaining payroll deductions stay in the employer account until employee claims are filed. Claims filed by the employee group tend to balance out over the year.
  • FlexRight caps the amount of salary reduction an employee may elect for a MedFlex Account at $2500, reducing the risk of the “Use It or Lose It” rule. The greatest risk comes from an employee who terminates employment during the plan year.
  • Unclaimed funds remaining in the FSA account at the end of the year also may be used to offset losses from terminated employees.
  • Employer FICA savings also greatly mitigate the risk.

The uniform coverage rule encourages employee participation by making funds available for their immediate use.

"Use it or Lose It" Rule

• The "Use it or Lose it" rule is contained in Section 125 of the IRS code. It says an employee must use all of the money in their flexible spending account each plan year, or they will lose it. However, the government recently added a 2 ½ months grace period to the rule, giving employees who overestimate their expenses, an extra 2 ½ months to spend down their account, including over-the-counter medications. Employees will also have an additional run out period to submit documentation for reimbursement. In the rare event that there are still unclaimed dollars in an employee account at the end of the run out period, they will be lost. However, careful planning and the grace period virtually eliminate that concern.

Careful planning will assure all employee account funds are used each year. FlexRight provides employees with planning tools to help them carefully estimate expected expenses. Employees should set up their savings accounts conservatively. Remember, employees also may use their flexible savings account to purchase many over-the-counter medicines and supplies.

Social Security Impact

Since employees enrolled in an FSA plan divert a portion of their income to the plan, their Social Security benefits may be impacted, but only slightly. The benefits of an FSA normally far outweigh whatever impact their salary reduction may have on Social Security benefits.

Non Discrimination Requirements

The plan can’t discriminate in favor of highly-compensated or key employees or those employees may lose the favorable tax treatment offered by the plan. FlexRight will ask you for information once a year to run a series of tests to ensure your group is in compliance.

Annual Reporting

For employers with 100 or fewer eligible employees, there are no reporting requirements. Employers with more than 100 eligible employees who have a health care reimbursement option under their FSA will need to file a Form 5500 each year. FlexRight will provide you with the information you’ll need to file the report.