If the FSA is "forfeitable" (that is, if the employee does not have the right to receive any of the unused amounts left in the account at the end of the year – also known as the “use-it-or-lose-it” rule), the reimbursements made through the account are excluded from the employee's taxable income. That means the IRS doesn’t receive any taxes on the money placed in an FSA.
What expenses can be reimbursed? The annual deductibles for the medical portion of an employer-provided health care plan, as well as expenses not covered by the plan (e.g., eye examinations, glasses, hearing aids, and orthodontia), can be reimbursed from a health FSA.
Currently, employees also can use money in a health FSA to purchase over-the-counter medications. Such nonprescription drugs include, among others, antacids, allergy medicines, pain relievers and cold medicines.
Reimbursements by FSAs are not subject to tax if the employee properly substantiates the purchase. Substantiation means that the employee provides independent verification of the purchase and paperwork (such as a receipt) describing the service or product, the date of the service or sale, and the amount.
What’s the change? The
No more stocking up on Tums? Because of the use-it-or-lose-it rule mentioned above, employees with small amounts of money left in their accounts just before the period ends for using it often stock up on items such as Tums or cold medicine. I’m sure that’s not what the IRS intended to encourage when it expanded the list of expenses that can be reimbursed through FSAs. But these unnecessary spending sprees could be avoided if the “use-it-or-lose-it” rule were repealed and employees were allowed to roll over the remaining money in their accounts from year to year. While such a repeal could help employees save for future health care expenses, it’s unfortunate that it would not, unlike the amendment discussed above, generate revenue for funding health care reform.
So, maybe I’ll be seeing you in the health aisle in a few months. Don’t stare at my shopping cart, and I won’t stare at yours.