IRS Discount “Coupons” – Flexible Spending Arrangements
Good to Know
If your doctor emailed a 35% discount coupon to your inbox, would you take the free money? Your clients that are under-utilizing Flexible Spending Arrangements to pay medical and child-care costs may be throwing away free money. How? Contributions to the Flexible Spending Arrangements discussed herein are not subject to income, Social Security, or even Medicare taxes. Such taxes can easily total 35% or more. Medical care and child care costs can be paid from FSAs using pre-tax dollars: the IRS version of a 35% or more discount coupon.
Our focus in this blog is upon:
- General Health Care Flexible Spending Arrangements,
- Limited Health Care Flexible Spending Arrangements, and
- Dependent Care Flexible Spending Arrangements.
Health Care FSA
A Health Care FSA is used to reimburse the unreimbursed (uninsured) costs to prevent, diagnose, treat, or cure an illness of the employee and his or her:
- Spouse,
- Dependent, and
- Child under the age of 27 (even if not a dependent).
The maximum annual contribution amount is $2,750 (2021, as indexed). Historically, only a portion of unused Health Care FSA funds ($550 in 2021) at the end of a plan year could rollover to the next plan year. However, the employer may allow up to 100% of an employee’s unused FSA funds to transfer from 2020 to 2021 and from 2021 to 2022 due to a temporary suspension of the rollover limit.
General and Limited Health Care FSAs
Health Care FSAs may be general or limited.
General Health Care FSA
- This FSA type is used to reimburse out-of-pocket costs for general medical, vision, and dental costs.
- Contributions to an employee’s General Health Care FSA in any year are not permitted if contributions are also made to the same employee’s Health Savings Account (HSA) in the same year.
- While a detailed discussion of Health Savings Accounts is out of scope for this blog, HSAs only allow one type of health insurance called a “high deductible health plan.” A General Health Care FSA could be used to pay the “high deductible” and is therefore prohibited.
Limited Health Care FSA
- A Limited Health Care FSA may not reimburse out-of-pocket general medical costs but may reimburse out-of-pocket vision and dental expenses.
- Contributions to a Limited Health Care FSA may be made in the same year as contributions are made to an HSA.
Dependent Care Flexible Spending Arrangement
An employee may contribute pre-tax dollars from his or her compensation into a Dependent Care FSA. The annual contribution may not exceed the lesser of:
- $5,000 ($2,500 if the employee files his or her federal income tax return as married filing separately),
- The employee’s annual compensation, or
- The annual compensation of the employee’s spouse if married.
Dependent care expenses may be reimbursed to the employee for dependent care costs for:
- A child under the age of 13 (under age 14 for 2020 and 2021 only), or
- An adult incapable of self-care.
Eligible expenses include pre-school child care, after-school child care, nursery school, summer camp, or adult daycare.
Summary
A savvy financial advisor will help his or her client take full advantage of IRS “generosity” in these FSA strategies. Why should your client pay $1.00 in their own money when the IRS is willing to kick in 35 cents or more? Be sure your clients are aware of the temporary changes, especially the potential rollover of 100% of unused flexible spending account balances for plan years 2020 and 2021.
Disclaimer
The information presented herein is provided purely for educational purposes and to raise awareness of these issues; it is not meant to provide and should not be used to provide tax, legal, compliance or financial advice. There are variations, alternatives, and exceptions to this material that could not be covered within the scope of this blog.
