Sep 19, 2023
IRS Memo Regarding Substantiation of Flexible Spending Account (FSA) Claims
September 2023
Source: Sterling Health Administrators
The sponsor of an Internal Revenue Code Section 125 cafeteria plan must address all areas of plan compliance and abide by guidelines issued by the IRS that apply to the substantiation of FSA reimbursements, including transactions using a debit card.
On April 28, 2023, the IRS Office of Chief Counsel released an Advice Memorandum that reviews and explains the long-standing substantiation rules that apply to Health and Dependent Care Flexible Spending Accounts offered under a Code Section 125 Cafeteria Plan. A properly governed and administered Cafeteria Plan enables plan sponsors and participating employees to exclude the value of elected benefits from taxable income up to the allowed amount.
Substantiation Requirements
Regulations governing the operation of Health and Dependent Care FSAs require that:
- only eligible expenses incurred during the period of a participant’s coverage may be paid or reimbursed by the plan;
- an eligible expense is incurred when the service or product is provided; and
- every claim for reimbursement or payment of expenses must satisfy substantiation requirements.
The Advice Memorandum serves as a reminder that ALL reimbursement claims for Health and Dependent Care expenses must be properly substantiated through acceptable practices. A plan that fails to meet all substantiation requirements is not considered a Code Section 125 Cafeteria Plan and will lose its tax advantages.
In general, a properly adjudicated FSA claim requires that the claim be supported by information from a provider that has been reviewed by a third party that is independent of the employee, the employee’s spouse, and dependents. The substantiating documentation must include:
- The name of the person who incurred the expense
- The provider of the service or product
- The date the service was provided or the date the product was purchased
- The nature of the service or product
- The dollar amount of the expense
The participant submitting the claim must also confirm that the expense has not been previously reimbursed and will not be submitted elsewhere for reimbursement.
Non-compliant Claims Substantiation
The Advice Memorandum described certain substantiation methods and practices that DO NOT satisfy substantiation requirements:
- Self-certification of medical expense by employee: there is no verification from an independent third party of information regarding the nature of the service or product, the date it was provided, or the amount of the expense.
- Sampling of expenses: all medical expenses charged to a debit card are paid or reimbursed but independent third-party substantiation is required only for a random sampling of expenses.
- De minimis claims substantiation level: independent third-party substantiation is required only if the amount charged to a debit card is above a specified threshold.
- Preferred providers: no independent third-party substantiation is required if a debit card charge is from certain health care providers.
- Advance approval of dependent care claims: the plan allows reimbursement of dependent care expenses before such services are provided.
Adverse Tax Consequences of failure to comply with FSA substantiation rules
The substantiation practices described above fall far short of meeting regulatory requirements. An FSA plan that does not require full substantiation by an independent third party of each reimbursement claim for a healthcare or dependent care expense is not compliant with the requirements imposed on a cafeteria plan by Section 125 of the Code. Accordingly, as stated in the Advice Memorandum, “…the amount of benefits that any employee elects under the cafeteria plan must be included in gross income and is wages for Federal Insurance Contributions Act (FICA) and Federal Unemployment Tax Act (FUTA) purposes subject to withholding.” The foregoing applies to all reimbursements received by a plan participant, even those which have been properly substantiated.
NOTE: Healthcare expenses that are paid with a debit card are subject to special substantiation rules.
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