Flexible Spending Account using Credits

[Guest Grumpy456]

What general tax rules apply to flexible spending accounts (FSAs) that incorporate credits? For example, Smithco provides its eligible employees with credits based on service. For 2005, Jerry, an eligible employee, has 1,000 credits. His employer-sponsored health coverage for the year is valued (by Smithco) at 800 credits, his dental coverage for the year is valued at 300 credits. Jerry uses 800 of his 1,000 credits to cover his health coverage and uses the remaining 200 credits to partially cover his dental coverage. Excess credits, had there been any, are forfeited. He pays for the remainder of his dental coverage through Smithco's medical reimbursement plan using pre-tax dollars. Smithco's FSA is not part of a Code Sec. 125 cafeteria plan. It seems to me that so long as Smithco's FSA satisfies Code Sec. 105, the value of the credits Jerry has been given is not includible in Jerry's income. Is that conclusion correct and, if not, why not? Thanks so much for your help.

[papogi]

Is this FSA being funded by credits, or by employee-elected payroll deductions. Your example shows credits being used for other benefits, not the FSA. Maybe you are using the term FSA to talk about the benefits, in general, and not specifically a flexible spending account? The credits themselves are used for employer-provided health benefits, and are protected from taxation by Section 106. The benefits received from that coverage are tax-free under Section 105.

[Guest gdburns]

An FSA whether through a Cafeteria Plan or not is subject to the Treas Regs for section 125.

However, what you describe might not be a FSA at all, especially since there is no cash option. Section 125 requires a choice between cash and qualified benefits.

What you described seemed more like a way of determining employer contribution towards the premium cost.

You also use the phrase "Smithco's medical reimbursement plan using pre-tax dollars" to describe how the employee pays the balance of the premium. This is questionable. The pre-tax employee salary reduction has to be done through a section 125 Cafeteria Plan. Also there would be no reimbursement. What you describe in this section should/could be a section 125 cafeteria Plan and/or a section 125 FSA and not a "medical reimbursement plan".

The use of benefits credits is fairly common in the public and union sectors.

As papogi stated the credits are tax free under section 106 and the benefits under section 105. Employee salary reductions are tax free under section 125. However, you have to have the correct structure and what you have described might not.

[Guest Grumpy456]

Thanks for the responses. Smithco refers to its plan as a flexible spending account--flexible in the sense that participants receive credits--based on service--and can then use those credits to purchase various benefits, e.g., health coverage, dental coverage, vision benefits and even additional vacation time. If they do not allocate all of their credits among the items on the benefits buffet, they lose them--they are not redeemable in cash and cannot be rolled into the next year. For example, Smithco's health coverage costs 800 credits for family coverage, 600 credits for the employee and his/her spouse and 400 credits for single coverage. If a single individual has been employed by Smithco for a long time and, as a result, has 2,000 annual credits, he/she might use 400 of those credits to purchase health coverage and another 400 for dental coverage and then use the balance to purchase additional vacation time or some other benefit on the benefits buffet.

For other employees, however, the credits might be insufficient to pay for health coverage, for example. A married employee with a family who has been employed for a short period of time may have only 100 credits. They could use their 100 credits to partially pay for health coverage. The value of the remaining 700 credits needed to purchase health coverage might cost $3,000. Smithco has set up a medical reimbursement plan into which employees can elect to make pre-tax contributions. Those contributions can then be used to reimburse the employee for certain medical-related items, e.g., the additional $3,000 in health insurance premiums. The medical reimbursement plan is designed to satisfy Code Sec. 105(b), according to the plan document.

The two plans are separate. The first (the plan with the credits, is referred to as the Smithco Flexible Spending Account Plan) and the second is referred to as the Smithco Medical Reimbursement Plan. Both plans were set up by a lawyer. Do you think there is a problem with the structure of the program(s)?

[Guest gdburns]

Any time someone uses language that is different from what is in general useage, I suspect that other things might also not be as they seem or claim.

Just because the plan documents make a claim that does not make it so.

A MERP does not usually, if at all, have any employee contributions, but a section 125 cafeteria plan/ FSA does.

Also very troubling is that "employees can elect to make pre-tax contributions. Those contributions can then be used to reimburse the employee for certain medical-related items, e.g., the additional $3,000 in health insurance premiums" Revenue Ruling 2002-3 points out that premiums paid with pre-tax money are not reimburseable under 105(b) or anywhere else.

I hope that incorrect information was conveyed to you. If not it seems that there are multiple problems beyond terminology.

[Guest Grumpy456]

Thanks for the responses. I appreciate them. I guess I'll have to follow-up with Smithco's lawyer for clarification.