Recently the Internal Revenue Service (IRS) released a Chief Counsel Memo confirming its long-standing position that all flexible spending account (FSA) expenses must be substantiated.
The Details:
Health FSA claims must be substantiated with two items:
1. Information from an independent third party describing the service or product, the date of the service or sale, and the amount of the expense.
2. A statement from the participant providing that the medical expense has not been reimbursed and that the participant will not seek reimbursement for the expense under any other health plan coverage.
Dependent care claims need only be substantiated with the requirements noted in number one above.
The IRS in the memo stated that certain practices do not meet the mandated substantiation requirements. These include:
· Self-certification by the employee
· Sampling (e.g.; every third claim substantiated)
· De minimis (only substantiating claims above a certain dollar amount)
· Favored providers (not substantiating claims from “trusted providers”)
· Substantiation in advance (claims must first be incurred prior to reimbursement from an FSA)
The IRS stipulated in its guidance that unsubstantiated claims are taxable reimbursement to the employee for federal income tax, social security, and Medicare. Unsubstantiated claims would in most cases also be subject to state income tax as well.
Further, the failure to substantiate all claims submitted under an employer’s cafeteria plan would invalidate the plan resulting in taxation for not only health and dependent care FSA claims but also for all deductions for medical insurance premiums. Additionally, all the tax benefits afforded to the employer such as reduced social security and Medicare taxes would be lost.
Next Steps:
Employers sponsoring cafeteria plans which include health and dependent care FSA’s must ensure that 100% of claims submitted under the plan are substantiated and have record keeping in place that can demonstrate that all claims were substantiated as required prior to reimbursing the employee.
Have Questions?
Please contact your dedicated service professional with any questions.