Every year, healthcare expenses make for a substantial part of the total expenditure of individuals in America. Needless to say, healthcare expenses can be overbearing if you do not have a medical insurance plan in place. However, recently, the IRS announced something great – employees could use their tax-free dollars to cover medical expenses that aren’t covered by other health plans.
Here employees indicate those working for companies/organizations that offer a flexible spending arrangement (FSA). Naturally, self-employed individuals are not eligible for this.
What is an FSA?
An FSA is a tax-deferred savings account (under Section 125 of the Internal Revenue Code) established by employers to help their employees pay for specific medical and dependent-care expenses that are usually not covered under the employer’s health insurance plan. FSAs allow you to contribute pre-tax dollars to a savings account set up by your employer. You can withdraw these tax-free savings to pay for various medical expenses later.
How does the FSA work?
To be able to use tax-free dollars for covering certain medical expenses, employees who are willing to contribute in an FSA can save up to $2,750 in payroll deductions throughout the 2020 plan year. Also, your employer may contribute to your FSA, provided the plan allows it. The money you put in an FSA is exempt from Federal Income Tax, Social Security tax, and Medicare tax.
As we mentioned earlier, employees can use the tax-free savings of their FSA funds to pay for a variety of medical expenses not covered, including co-pays, deductibles, qualified health insurance premiums, out-of-pocket medical costs, medical products, eyeglasses, hearing aids, etc. throughout the year. Apart from these expenses, FSA funds can also be used to pay for medical services such as dental and vision care.
Another important thing about the FSA is the “use-or-lose provision,” which mandates that all participating employees must incur eligible expenses by the end of the plan year or forfeit the amount not spent.
Provision for employers to offer an option to extend the time period for spending the FSA funds for their employees:
- The carryover option – Under this plan, an employee can carry over a max of $500 of unused FSA funds to the following plan year. So, if you have a certain amount of unused FSA funds by the end of 2019, you can carry those funds over to 2020 and use them.
- The grace period option – This plan gives an employee two and a half months of grace time after the end of a plan year to incur eligible expenses in the following year. So, if the plan year ends on December 31, 2019, you will have till March 15, 2020, to use the unspent FSA funds.
An employer can only offer any one of the two options mentioned above and not both.
Although employers are not “required” to offer FSAs to their employees, they can receive tax benefits if they establish FSAs. As in, if an employer sets up FSAs for his/her employees, he/she does not need to pay the employer portion of the Social Security tax (which stands at 7.65% of each employee’s taxable income) on employee contributions to FSAs. This means that payroll taxes get reduced by 7.65% of the total employee contributions made to the FSA.
For further information on FSAs, you can check out IRS’ Publication 969, Health Savings Accounts, and Other Tax-Favored Health Plans.