A medical flexible spending account (FSA) is a tax-advantaged account maintained by employers where employees can set aside a portion of each paycheck to pay for out-of-pocket medical expenses. No payroll taxes are due on funds allocated to an FSA, and the employee can use the money to pay for qualified medical expenses throughout the year.
Employees have to decide before the start of the plan year (during open enrollment) whether they want to contribute to their FSA, and if so, how much they want to contribute. The amount is then divided out across the employee’s paychecks for the whole year, although the full amount is available for withdrawal as of the first day of the plan year. Normally, employees cannot make changes to their FSA election during the plan year unless they have a qualifying event. But in response to the COVID-19 pandemic, the IRS is allowing (but not requiring) employers to relax these rules in 2020: Under the new guidance, employers can let employees sign up for the company’s FSA, cancel their FSA contributions, or change the amount that they contribute each pay period for the remainder of 2020.
There is a “use-it-or-lose-it” requirement with FSAs: Any money left in the account at the end of the plan year (or by March 15th of the following year if the employer offers a grace period) is lost to the employee, so it’s important to only allocate for expenses that you know you’ll incur (instead of a grace period, employers can opt to allow employees to carry over up to $500 in unused FSA funds from one plan year to the next). For 2020 only, in response to the COVID-19 pandemic, the IRS has relaxed the rules a bit. For FSAs with grace periods that end in 2020, or plan years that end in 2020, employers are allowed (but not required) to let employees have until the end of 2020 to use up the funds in their FSAs.
FSAs can be used in conjunction with high deductible or more traditional health plans.
As of 2011, the ACA prohibited the purchase of over-the-counter medications with FSA funds, unless a doctor wrote a prescription for them. But Section 4402 of the 2020 Coronavirus Aid, Relief, and Economic Security (CARES) Act changed that. The CARES Act eliminated subsection (f) of Section 106 of the Internal Revenue Code. That section had previously prohibited the purchase of non-prescription over-the-counter medications with FSA money (it used to say “reimbursement for expenses incurred for a medicine or a drug shall be treated as a reimbursement for medical expenses only if such medicine or drug is a prescribed drug (determined without regard to whether such drug is available without a prescription) or is insulin.” That provision was eliminated under the CARES Act).
Section 4402 of the CARES Act also changed the rules to allow menstrual products to be purchased with FSA funds. The new rules that allow FSA funds to be used for over-the-counter medications and menstrual products are retroactive to January 1, 2020, and are permanent changes (ie, they will remain in place even after the COVID-19 emergency period ends).