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:
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):
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.