Health flexible spending accounts are operated through an employer's cafeteria plan under section 125 of the Internal Revenue Code. They allow employees to put money aside, pre-tax, to be reimbursed for eligible health care expenses. 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. IRS 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.
An 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.
For information about BAS’ FSA administration and processes for employers with the Benny Card, please refer to today’s MyEnroll Feature article.
