IRS Memo to Plan Sponsors and TPAs

The Internal Revenue Service (IRS) recently issued a memo to Plan Sponsors and TPAs as a helpful reminder to conduct a Section 125 Health Flexible Spending Account (FSA) expense and approval practices review to ensure compliance with current applicable rules. While the rules have been in place for many years, this memo reiterates that going forward, it will be more difficult for cafeteria plans that are not in compliance to say they did not know the rules.   

An annual Section 125 Plan review will confirm the following: 

  • The plan is in writing and operating in accordance with the written plan.
  • The Plan Year is defined.
  • Insurance benefits, carriers, and descriptions are provided to employees.
  • The Eligibility of insurance requirements and benefits offered to employees is consistently offered to similarly situated employees.  
  • Flexible Spending Account (FSA) minimum and maximum contributions (if offered); and Non-elective (employer) contributions and elective (employee) contributions are explained in detail.

Reimbursements of medical expenses to an employee from a health FSA under the cafeteria plan are included in an employee’s gross income if any employee expense reimbursed by the health FSA is not fully substantiated.  If the plan does not require an independent third party to fully substantiate reimbursements for medical expenses, the cafeteria plan fails to operate in accordance with substantiation requirements and is not considered to be a cafeteria plan within the meaning of Code Section 125. An FSA allows employees to use up to $3,050 (2023 plan year) in pre-tax earnings dollars to pay for eligible out-of-pocket medical, dental and vision care expenses not covered by other insurance. Some employees may be confused to see “Cafe 125” listed on their W-2 form. 

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