OneDigital Benefits Compliance Consulting

ISSUED 01/26/2021

Following the 2013 regulation that permits employees to carry over up to $500 of unused FSA funds, employers had many lingering questions regarding how amounts carried over affected employees’ eligibility to participate in an HSA. IRS’s Chief Counsel recently issued a memorandum that addresses issues involving FSA/HSA interaction as well as providing clarity as to how employers should correct improper (e.g., unsubstantiated) FSA payments.

• Individuals participating in FSA cannot make HSA contributions even if s/he  has an FSA due to a carryover of unused amounts from the prior plan year.

• Individuals who have an FSA may not contribute to an HSA during the entire  FSA plan year-- even for months in the plan year after the participant exhausts the FSA carryover balance.

• Individuals who have an FSA who elect to participate in an HSA-compatible health FSA for the next year may also elect to have any unused amounts from the general-purpose health FSA carried over to the HSA- compatible health FSA.

• An individual who elects to deposit a carryover balance from a general-purpose health FSA into an HSA compatible health FSA in the following year may contribute to an HSA during that following year.

• A cafeteria plan that offers both a general-purpose health FSA and an HSA compatible health FSA may automatically deem any employee who joins an HDHP for the following year as having enrolled in the HSA- compatible health FSA. Thus, any unused amounts from the general-purpose health FSA would carry over to the HSA compatible health FSA for the following year.

• A cafeteria plan may provide that a participant in a general-purpose health FSA with a carryover feature may decline or waive the carryover balance before the next plan year, and remain eligible to make HSA contributions.

• If an employee elects to carry over unused amounts from a general-purpose health FSA to an HSA- compatible health FSA, s/he  may use the remaining balance for any permissible medical expenses incurred before the general-purpose health FSA plan year ends. Any covered claims must be timely reimbursed up to the amount elected for the HSA-compatible health FSA plan year. Claims over the elected amount may be reimbursed after the runout period when the amount of any carryover is determined.

Incorrect FSA Payments - The IRS also clarified how employers should correct incorrect payments from FSA accounts by announcing that employers should use the same methods previously announced that apply in the context of erroneous payments made using a health FSA debit card -- even if overpayments do not relate to a debit card.

• Assuming a debit card is involved, until the employer recovers the improper FSA payment, it must deactivate the debit card, and the employee must use other methods to request FSA reimbursements, such as submitting a hard-copy receipt or invoice.

• Employee must repay the improper FSA payment to the cafeteria plan.

• If employee fails to make the repayment, the employer must withhold the improper payment amount from the employee’s pay.

• If the employer is unable to recover the full amount, claims substitution or offset must be used where possible. So, if an employee receives an improper payment of $200 and subsequently submits a substantiated claim for $250, the employer reimburses only $50.

• If the employer is still unable to recover the improper payment, it should be treated in the same way as any other business debt.

Employers may apply these correction procedures in any order (as long they are consistent for all). An employer may proceed to the fifth step only after exhausting the other steps. Correction procedures should be applied during the plan year in which the improper payment was made. Finally, repaid amounts are available for reimbursing other claims incurred during that plan year (or in the next plan year, if the plan has a carryover feature).

If the employer treats the improper FSA payment as a business debt because it was not repaid by the employee, the amount is considered income to the employee and thus subject to withholding for federal income tax, FICA and FUTA purposes. Additionally, the employer should report it as income on Form W-2 in the tax year in which the employer forgives the debt.