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FSA deductions from final paycheck


Guest Barbara H
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Guest Barbara H

An employee requested that I not withhold their Flexible spending account deduction from their last paycheck. The check is for hours worked before termination. My FSA vendor said I have to deduct. Can anyone point me towards a resource I can share with the ee when they don't believe me? I couldn't find anything at the IRS site. Thanks!

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There is no pretty statement in the regs which says in one line exactly what you need (big surprise). The IRS spells out the rules for participants in FSA's and pretty much assumes an employee knows if he/she is participating or not. Here's a potential response to your employee:

Prop. Treas. Reg. 1.125-2, Q&A-7(B)(6) says that "medical expenses reimbursed under a health FSA must be incurred during the participant's period of coverage under the FSA". What is the last day the employee is participating in the FSA? If the employee has paychecks which are a result of hours worked while covered under an FSA, then the employee has to pay for the benefit. If the employee does not want an FSA deduction from the last pay, then the FSA must have ceased on a date prior to his/her termination. Was there a status change or any qualifying event that would allow him/her to cease participation in the FSA prior to termination? Probably not. He participated past that date, so must pay for the benefit past that date. Payroll deductions should reflect amounts paid for benefits of all types (medical, dental, life insurance, FSA) up to the termination date, the last date of eligibility for benefits.

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  • 4 weeks later...

I actually have a similar situation with a slightly different twist. The employee terminated and has 4 weeks of vaction pay due to him. Can pretax deductions be taken for the health FSA? I always thought, similar to the final paycheck, that services must be incurred prior to their date of termination and pretax amounts cannot be taken from any outstanding vaction pay or severance pay due to the employee. The employee would have the option of COBRA.

Any suggestions? :confused:

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This is a good question. I know that IRS officials have "informally indicated that employee flex plan contributions may be paid from 'salary substitutes' such as severance pay." Outstanding vacation pay is definitely a salary substitute. Some states, however, do not allow flex plan contributions to be taken from salary substitutes. So, first you'll have to find out the rule of the state in question. Also, if an employer wanted to take this iffy, but possibly defensible approach to flex plan contributions and salary substitutes, I would think it should be clearly outlined in the plan doc in the separation from service/termination area.

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papogi,

Thanks for the information on the "state specific" requirement. I will check that out. I appreciate your response.

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