Flexible Spending Accounts
An FSA allows an employee to set aside a designated portion of their earnings on a pre-tax basis to pay for qualified expenses as set forth by IRS guidelines. Employees may set aside pay in to the Health FSA and/or Dependent Care FSA to help them pay for out-of-pocket expenses related to medical care, dental care, orthodontia treatments, eye exams, glasses, contacts, eligible over-the-counter items, daycare, pre-school, before and after school care programs and summer day camps. Money deducted from an employee's pay into their FSA is not subject to payroll taxes and provides payroll tax savings for both the employee and the employer.
Health FSA
The Health FSA is used to pay for medical expenses not paid for by insurance; this usually means deductibles, copayments, and coinsurance out-of-pocket expenses owed by a patient that was not paid by insurance. Additionally, many expenses not covered by a health plan, such as dental and vision expenses and eligible over-the-counter (OTC) items/medications, including a first aid items are also eligible.
A Health FSA cannot pay for insurance premiums, cosmetic or toiletry items, cosmetic surgery, controlled substances (in violation of federal law), or items that improve "general health". All items must be intended to treat or prevent a specific medical condition—this can be as significant as diabetes or pregnancy, or as minor as skin cuts. Generally, allowable items are the same as those allowable for the medical tax deduction, as outlined in IRS publication 502.
Limited FSA
Generally used in conjunction with a health savings account (HSA), a Limited Purpose FSA offers the same tax advantages as the Health FSA, but the use of the funds are, as the name suggests, more limited to reimburse employees for designated eligible expenses such as for dental, vision, over-the-counter or preventative care expenses.
When being used in conjunction with contributing to the HSA bank account, additional medical expenses may also be reimbursed using the limited purpose funds; however, they may only be reimbursed after the IRS-mandated minimum deductible has been met.
Dependent Care FSA
FSAs can also be established to pay for certain expenses to care for dependents that live with you while you are at work. While this most commonly means child care, for children under the age of 13, it can also be used for adult day care for senior citizen or adult dependents that live with you, such as parents. Funds cannot be used for overnight summer camps, general summer sports leagues or for long term care for parents that live elsewhere (such as in a nursing home).
The dependent care FSA is federally capped. While married spouses can each elect to have an amount deducted from their paycheck and applied to expenses, at tax time all withdrawals in excess of the federal cap are recaptured for tax purposes. 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.
Unmarried couples can each deduct and use up to the federal cap. However, these expenses are subject to the "qualifying child" rules, which usually means unmarried couples cannot pay expenses for the same child.
FSA Cards
Many employers choose to issue a debit card to their employees who participate in the FSA. Participants may use the debit card to pay for their FSA-eligible expenses at the point of sale—giving each participant immediate access to their benefit dollars.
Pharmacies and grocery stores who accept the FSA cards as payment use software that runs behind the register to read the bar codes of the items being purchased to allow for only eligible items to be purchased.
Employees will still be required to provide itemized documentation for expenses paid with the debit card when the expense cannot be electronically substantiated.