Business Owners Get More Bang From Flex Plan Bucks

Although all the effects of the Affordable Care Act (ACA) are still unclear, it’s likely that health insurance costs will continue to increase in the future. Business owners may require greater health plan contributions from participating employees. In addition, this health care law already has made it more difficult for individuals to deduct medical outlays: For most taxpayers, only expenses over 10% of adjusted gross income (AGI) are tax deductible, versus a 7.5% hurdle under prior law. (The 7.5% rule remains in place through 2016 for individuals 65 and older and their spouses.)

            In this environment, business owners stand to benefit substantially by offering a health flexible spending account (health FSA). These plans allow employees to set aside up to $2,500 per year that they can use to pay for health care expenses with pretax dollars.

            Example 1: XYZ Corp. offers a health FSA to its employees. Harvey James, who works there, puts $2,400 into the plan at the beginning of the year. Each month, $200 will be withheld from Harvey’s paychecks, and he’ll owe no income tax on those amounts.

            Going forward, Harvey can be reimbursed for his qualified medical expenses that are not covered by his health plan at XYZ. Possible examples include health insurance deductibles, copayments, dental treatments, eyeglasses, eye surgery, and prescription drugs. Such reimbursements are not considered taxable income. Thus, Harvey will pay those medical bills with pretax rather than after-tax dollars.

Health FSAs and the Affordable Care Act

Under the ACA, there are limitations on an employer offering a health FSA to their employees. Standalone health FSAs can only be offered to provide limited scope dental and vision benefits. An employer can only offer a health FSA that provides more than limited scope dental and vision benefits to employees if the employer also offers group major medical health coverage to the employees.

Additionally, an employer can make contributions to an employee’s health FSA. However, under the ACA, the maximum employer contribution the plan can offer is $500 or up to a dollar-for-dollar match of the employee’s salary reduction contribution.

Ultimately, these additional new rules can affect whether an employer can offer a health FSA and the amount of any optional employer match.

Employer benefits

A health FSA’s benefits to participating employees are clear. What will the business owner receive in return? Chiefly, the same advantages that come from offering any desirable employee benefit. Recruiting may be strengthened, employee retention might increase, and workers’ improved morale can make your company more productive.

            There’s even a tax benefit for employers, too. When Harvey James reduces his taxable income from, say, $75,000 to $72,600 by contributing $2,400 to a health FSA, he also reduces the amount subject to Social Security and Medicare withholding by $2,400. Similarly, XYZ Corp. won’t pay its share of Social Security or Medicare tax on that $2,400 going into the health FSA.

Counting the costs

However, drawbacks to offering an FSA to employees do exist. The plan, including reimbursements for eligible expenses, must be managed. Many companies save headaches by hiring a third-party administrator to handle a health FSA, but there will be a cost for such services.

            In addition, companies offering health FSAs to employees should have enough cash to handle a large demand for reimbursement, especially early in the year.

            Example 2: Kate Logan also works for XYZ and she chooses to contribute $1,800 to her health FSA at the beginning of the year: $150 a month, or $75 per each semimonthly paycheck. Just after her first contribution of the year, Kate submits paperwork for a $1,000 dental procedure. XYZ might not have trouble coming up with $1,000 for Kate, but there could be a problem if several employees seek large reimbursements after making small health FSA contributions.

Using It, Losing It

Employers also should be sure that employees are well aware of all the implications of health FSA participation. For years, these plans have been “use it or lose it.” Any unused amounts would be forfeited at year end.

            Example 3: Mark Nash participated in an FSA offered by XYZ several years ago. He contributed $2,000 but spent only $1,600 during the year. The unspent $400 went back to XYZ.

            In 2005, the rules changed. Now, if the FSA permits, participants have until mid-March of the following year to use up any excess. If XYZ had adopted this optional grace period, Mark Nash would have had an extra 2½ months to spend that leftover $400 on qualified medical costs.

            Yet another change occurred in late 2013—a $500 option. Under this provision, FSA plans can be amended to allow each employee a carryover of up to $500, from one year to the next. Plans with this $500 carryover provision cannot allow a grace period as well. If your company now has an FSA with this optional grace period, it will have to amend the FSA to eliminate the grace period in order to add the $500 carryover provision. 

            In addition to explaining all of the rules on possible forfeitures, employers offering an FSA should be sure their employees know about a possible impact on Social Security benefits. As mentioned, FSA contributions aren’t subject to Social Security; those contributions aren’t included in official compensation, for Social Security purposes. Employees should know that reduced compensation today might reduce Social Security benefits tomorrow. Companies that spell out all the FSA implications to workers may reduce misunderstandings and future complaints.