Last week the Internal Revenue Service, Office of Chief Counsel, released a memorandum describing correction procedures for improper payments from a health flexible spending account plan. The guidance explains how to correct improper debit card payments and how an employer should treat these payments for tax purposes. While the memorandum is not formal guidance, it does give an insight into the IRS' view on the steps an employer should take with respect to an unsubstantiated health FSA expenses paid with a debit card.
Health flexible spending accounts are operated through an employer's cafeteria plan under section 125 of the Internal Revenue Code. In order to receive tax-favored treatment, the FSA must meet certain requirements. One of these requirements is that the FSA may only reimburse expenses incurred for medical care. Another requirement is that the medical care expense must be substantiated with appropriate supporting documentation.
Some FSAs allow purchases to be made with a debit card and the card payments reduce the outstanding FSA balance. In some cases, the expense paid with the debit card can be automatically substantiated at the point of sale (for example, when the card is swiped for a copayment under the plan). In other cases, the expense must be substantiated with documentation after the fact.
Sometimes, an FSA participant does not provide proper documentation for an FSA purchase made with a debit card. An improper payment includes a payment that is not properly substantiated, as well as a reimbursement of an expense that is later identified as not a qualified expense. The IRS’ new guidance provides the following process for correcting improper payments:
- Until the amount of the improper payment is recovered, the debit card must be deactivated and the employee must request payments or reimbursements through other methods.
- The employer must demand that the employee repay the cafeteria plan an amount equal to the improper payment.
- If after the demand for repayment, the employee fails to repay the amount of the improper charge, the employer should withhold the amount of the improper charge from the employee's pay or other compensation, to the extent allowable by law.
- If any part of the improper payment remains outstanding after attempts to recover the amount, the employer should apply a claims substitution or offset to resolve the improper payment.
- If after applying all of the procedures, the employee remains indebted to the employer for improper payments, the employer, consistent with its business practice, should treat the improper payment as it would any other business indebtedness.
Prior to the new guidance, it was widely thought that the IRS correction procedures had to be applied in the order presented. Now, it is clear that that an employer may apply the correction rules in any order, so long as the order is consistently applied for all participants in the FSA. However, the employer may treat the improper payment as a business indebtedness only after it applies the other correction methods (deactivating the debit card, demanding repayment, etc.).
If the employer exhausts all of the correction procedures and treats the improper payment as a business indebtedness, the payment should be reported to the employee as wages on Form W-2 to the extent the employer forgives the indebtedness. The amount will be subject to withholding for income, FICA and FUTA tax and is reportable in the taxable year of the employee in which the indebtedness is forgiven.
BAS assists employers in satisfying their Internal Revenue Code requirements for substantiating FSA expenses paid with a debit card. BAS has established the following process for a participant who uses the Benny Card for an expense that cannot be automatically substantiated at the point of sale (e.g., is not a pre-loaded medical copayment amount):
- Benny Central will send the participant a letter requesting supporting documentation for the expense. If a valid email address is entered into MyEnroll.com for the participant, the letter will be sent by email (from @bennycentral.com). If there is no email address associated with the account, the letter will be mailed to the participant's home address.
- The participant will have 30 days to respond to the request for documentation. If a response is not received within 30 days, the participant's Benny Card will be suspended and the participant will receive another notification again asking for supporting documentation.
- The participant's Benny Card will remain suspended until adequate documentation is provided or until the participant repays the account with after-tax dollars.
- If additional documentation is provided, that documentation will be reviewed to determine if the expense may be properly paid from the FSA. If it is determined that the expense may be properly paid from the FSA, the claim will be substantiated and the Benny Card will be reactivated.
- If after review of the documentation, it is determined that there is not sufficient information to substantiate the claim, the participant will be sent another notification requesting more information. The participant will have 14 days to respond to the request for more information.
- If, based on all of the information provided, it is determined that the expense is not an eligible expense, the participant will receive a notice asking the participant to send a check in the amount of the expense to reimburse the FSA. When BAS receives the repayment and the FSA is reimbursed for the ineligible expense, the participant's account will be credited and the Benny Card will be reactivated.
- If the participant does not respond to the Benny Central notifications within the identified time frames, or if the participant does not repay an expense that is determined to be an ineligible expense, the Benny Card may be permanently suspended and will not be reactivated.
Please note that participants may continue to submit paper claims while the Benny Card is suspended.
For more information about the Benny Card or the new IRS guidance, please contact your account manager or info@BASusa.com.
