Since you asked: Are FSA claims required to be substantiated?

Question

Must flexible spending account (FSA) claims be substantiated? If so, what is considered sufficient substantiation?

Answer

Yes. Under the tax code, an employee must provide proof from an independent third party that funds used from a health or dependent care FSA were used for eligible expenses. Without proper substantiation, such reimbursements will be included in an employee’s gross income rather than being tax-free.

Many employers provide health FSAs and/or dependent care FSAs through cafeteria plans that meet the requirements of Internal Revenue Code section 125 (i.e., section 125 cafeteria plans). Some employers self-administer their FSAs, while others contract with a third-party administrator (TPA), especially for processing claims. ERISA, which applies to health FSAs but not dependent care FSAs, requires plans to follow certain claims procedures but does not impose substantiation requirements. Instead, substantiation requirements for FSAs are imposed under the Internal Revenue Code — requirements that have been in force since FSAs became available.

FSA claims substantiation general rule

FSAs are intended to allow employees to contribute to a health or dependent care account using pre-tax salary reductions through a section 125 cafeteria plan and receive tax-free reimbursements for qualifying expenses from the account. Qualifying expenses are those listed in section 213(d) of the tax code for health FSAs and in section 129 for dependent care FSAs.

Employees must substantiate FSA claims with information from an independent third party. For a health FSA claim, the participant must also provide a statement 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. Any reimbursed expense that is not fully substantiated must be included in an employee’s gross income and counted as wages subject to withholding.

A section 125 cafeteria plan must require an independent third party to fully substantiate reimbursements for FSA expenses in order to maintain its tax-favored status.

Recently, the IRS Office of Chief Counsel issued a memorandum on the FSA claims substantiation process and described situations when substantiation is sufficient and when it is not.

Sufficient substantiation

The following situations meet substantiation requirements:

1. The health FSA only reimburses qualified expenses that are substantiated by an independent third party with information that describes the service or product, the date of service or sale, and the amount of the expense (i.e., the employee’s cost share), such as an explanation of benefits from an insurance company (or group health plan). The health FSA also requires the employee to certify that any expense has not been reimbursed by insurance or otherwise and that the employee will not seek reimbursement from any other plan for the expense.
2. The health FSA provides debit cards that meet IRS requirements that can be used to reimburse section 213(d) medical expenses.

Insufficient substantiation

The following situations do not meet substantiation requirements:

1. Self-certification. The health FSA reimburses employees for medical expenses for which an employee only submits information describing the service or product, the date of service or sale, and the amount of the expenses but does not provide a statement from an independent third party to verify the expenses. The health FSA does not substantiate debit card charges with a statement from an independent third party.
2. Sampling. The health FSA reimburses all charges to the FSA debit card and only requires substantiation of a random sample of otherwise unsubstantiated charges to the debit card through third-party information describing the service or product and the date of the service or sale.
3. De minimis. The health FSA does not require substantiation of a charge to the FSA debit card through additional third-party information describing the service or product and the date of the service or sale if the charge to the debit card is less than a specified dollar amount.
4. Favored providers. The health FSA does not require substantiation of a charge to the FSA debit card through additional third-party information describing the service or product and the date of the service or sale if the charge to the debit card is from certain dentists, doctors, hospitals or other healthcare providers.
5. Advance substantiation for dependent care assistance program. The dependent care FSA allows employees to submit a form in advance of receiving the dependent care, attesting to the amount of dependent care expenses they will incur in the upcoming year, and automatically reimburses a prorated amount each pay period. This is the case even if the FSA requires employees to notify the plan sponsor if their dependent care situation changes and they will not incur the amount of qualified dependent care expenses to which they attested for that year.

Going forward

• Employers should review their internal claims substantiation processes or those of their TPAs to ensure they comply with IRS rules in order to maintain tax-favored status under section 125.
• Employers that are renewing contracts for FSA administration with a TPA, implementing FSAs with TPA services or changing TPAs should review the TPA’s claims substantiation procedures and contract language for legal compliance with all applicable laws and tax-favored status under section 125.