FSA & Terminated Employee

[Guest pmcgroine]

I've been reviewing some of the posts re: FSAs. Could someone please let me know if I'm on the right track with the following assertion:

1) If an employee has exhausted her FSA benefits prior to the end of the plan year and also terminates employment prior to the end of the plan year, her employer cannot seek reimbursement of any uncollected "premiums" she would have otherwise paid. (e.g., Assume the FSA has a calendar year plan year, and ER is permitted to make bi-weekly deductions from EE's "salary" to cover the EE's contributions to the plan. In January EE incurs $1500 in eligible medical expenses, the maximum allowed under the plan and terminates her employment in June. The ER may not deduct her remaining contributions due the plan from her last paycheck.) Right or wrong? Could the plan document affect the ER's right to recoup losses?

[Mary C]

According to the regs, the employer has to be "at risk" for the full amount from the first day of the plan year and cannot recoup any amounts they may have reimbursed the employee over the amount the employee contributed if the employee should terminate employment.

[Guest wwcpa]

I understand the "at risk" component but I have seen plans where they say the will withhold from the final paycheck?

It seems like the employer is already at risk for expenses of the plan?

Also - would benefits paid out to an employee in excess of his/her contributions to the plan be taxable to the employee?

It seems like this creates a way an employee to max out their election - plan a major surgery early in the year; collect the reimbursement and quit.

[papogi]

You can't withhold an amount from the last paycheck to cover the employee's potential loss based on the claims history of the terminating employee [125-2 Q-7(B)(2)].

Benefits paid in excess of premiums collected are not taxable to the employee. The IRS sees an FSA as a form of insurance. That's why there needs to be risk-shifting, that's why premiums paid cannot be tied to claims experience, and that's how Section 105 allows the benefits (regardless if they exceed premiums) to be non-taxable to the employee.

You are right that an FSA-savvy employee can abuse the system. They can with their regular health or dental coverage, as well. It's just the nature of something that has principles of insurance tied into it. In the end, employers always have forfeitures, and they always "make money" by offering an FSA.

[david rigby]

That is correct. In other words, both the employee and the employer have to be "at risk", which the essential element in insurance. That characteristic is the underlying reason for flex accounts in the first place.