FSA & Cafeteria Plan

Sample Reports

What is an FSA & Cafeteria Plan?
An FSA or Flexible Spending Account allows an employee to set aside a portion of his or her earnings to pay for qualified expenses. These expenses are established in a cafeteria plan. The Cafeteria plan offers a choice of cash or benefits, most today are operated through a "salary reduction agreement". Such agreements are often called pre-tax deductions. Salary reduction contributions are not actually received by the participant. Therefore, those contributions are not considered wages for federal income tax purpose.

Who Contributes to a FSA?
Contributions are provided by the employee. The amounts deducted are determined by the employee. The employee chooses how much of their earnings are to be deducted from their pay into the FSA to pay for the qualified expenses established in the cafeteria plan.

Who can Sponsor a Cafeteria Plan/ FSA?
Any employer can sponsor a cafeteria plan for its employee’s, no matter what its size. Eligible employers include corporations (Subchapter S or Subchapter C), partnerships, non- profit organization’s government entities, limited liability companies (LLC’s), limited liability partnerships (LLP’s), and sole proprietorships. 

Who can participate in a Cafeteria Plan/ FSA?
Only employees of the sponsoring employer can participate in the cafeteria plan. Some individuals are not eligible to participate in a cafeteria plan.

  1. Self- Employed individuals (but they can sponsor a plan)
  2. Partners in a partnership (but the partnership can sponsor a plan)
  3. A more- than 2%- shareholder in a Subchapter S corporation (the corporation can sponsor the plan, even though the more- than- 2%- shareholder cannot participate).

What can the money be used for?
The money deducted from the employee’s earnings through the cafeteria plan is placed into the FSA. This money is then used for either medical expense and or for dependent care expenses.

Are there different types of FSA’s?
Most cafeteria plans offer two different flexible spending accounts.

  1. Qualified Medical Expenses
  2. Dependent Care Expenses

Participation in one type of FSA does not affect participation in another type of FSA; however, funds cannot be transferred from one FSA to another.

  1. Medical expense FSA is the most common type of FSA. It is used to pay for medical expenses not paid for by insurance such as deductibles, co-payments and coinsurance for the employee’s health plan. This may also include expenses not covered by the health plan, such as dental and vision expenses and over-the-counter drugs. All items must be intended to treat or prevent a specific medical condition.

    Annual caps for a medical FSA will vary by employer. There is no cap on medical FSA’s. Employers however, will usually limit the annual amount each employee may contribute; this will reduce the risk of pre-funding. Should the employee leave or be terminated from employment and no longer pay into the plan, the employer does not recapture their pre-funding from the employee’s payroll deduction.

  2. Dependent care FSA is used to pay for certain expenses to care for dependents that live with you while you are at work. This can also be used to adult daycare for senior citizen dependents that live with you, such as parents.

    Dependent care FSA is federally capped at $5,000 per year. Unlike medical FSA’s dependent care FSA’s cannot be “pre-funded”. Employees are only able to receive reimbursement as funds are deposited into the FSA. While medical FSA’s almost always favor the tax payer, dependent care FSA’s are a more complicated matter because they are a tradeoff between pre-tax deductions and tax credits, not itemized deductions like medical FSA’s if married, both spouses must earn income in order for the dependent care FSA to work. The only exception is if the non-earning spouse is disabled or a student. If one spouse earns less than $5,000 then the benefit is limited to whatever that spouse earned. 

What are the disadvantages of an FSA?
An FSA allows money to be deducted from an employee’s paycheck pre-tax and then spent on qualified expenses.

Example: a person in the 28% Federal marginal tax bracket and an example 4% state tax (along with FICA taxes of typically 7.65%, for a total tax of almost 40%), could deduct $2,000 and put that money into an FSA for healthcare. This would result in almost $800 in tax savings.

Net Income = (Income – Medical Expenses) * (1 – Tax Rate)

  • Income = $50,000
  • Tax Rate = 40%
  • Medical Expenses = $2,000
  • Net Income = $28,800

There is a straight – line savings of $800, if you spend everything in the FSA account and you need everything you purchase.

What are the disadvantages of an FSA?
One of the major drawbacks with an FSA is that the money must be spent within the coverage period. The coverage period is defined as the time that you are covered under the cafeteria plan during the “plan year”. Any money left unspent at the end of the coverage period is forfeited back to the company. This has also been referred to as the “use it or lose it” rule. The coverage period usually ceases upon termination of employment.

A second requirement is that all applications for refunds must be made by a date defined by the plan. If funds are forfeited, this does not eliminate the requirement to pay taxes on these funds is such taxes are required. For example, if a single person elects to withhold $ 5,000 for child care expenses and gets married to a non- working spouse, the $5,000 would be forfeited but taxes would still be owed on the amount.

Also, the annual contribution amount must remain the same throughout the year unless certain qualifying events occur, such as the birth of a child or death of a spouse.

FSA Changes for beginning 2013
Maximum Annual Limit of $2,500 on Health FSA Salary Reductions/Pre-Tax Contributions An annual cap of $2,500 per participant, per plan year applies the first day of the first plan year beginning on or after January 1, 2013.

Required for Health FSAs – Health Care Reform Code section 125(i)(1)
Employers with plans that currently allow a health care FSA election of more than $2,500 must amend their plan documents before Jan. 1, 2013 to comply with the new limit.
Sponsors of non-calendar-year plans should consider acting now by adopting the new limit as of the first day of the plan year, rather than waiting until January 1, 2013.

For example, if an employer’s plan year begins September 1, 2012 and ends August 31, 2013, it can amend its plan so that the contribution limit is effective as of September 1, 2012.

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