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Veronica

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What responsibility is it for the 3rd party FSA provider to process FSA claims correctly. Example if an employee sends in a claim and there is a possibilty the item or service is not eligible or my need more clarification, like a Dr's letter but it is paid out without asking for more clairification,  is it ok for a 3rd party provider to not looking into the expense furthur, like holding it for more info. And their thought process is ultimately its on the employee if they claim something and shouldn't have and it was reimbursed. Where is the line that the 3rd party FSA provider must hold a claim or servi e for more clarification to either reimburse or deny as not an eligible expense?

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I'm not a practitioner in that area, but I would expect (hope) whatever service agreement the employer has with the FSA TPA delineates the TPA's responsibilities, if any, in adjudicating claims.

Kenneth M. Prell, CEBS, ERPA

Vice President, BPAS Actuarial & Pension Services

kprell@bpas.com

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The TPA acts on behalf of the cafeteria plan, which is sponsored by the employer.  The employer plan sponsor is required to substantiate all claims.  That responsibility is delegated to the FSA TPA. 

This is not something that is ultimately on the employee.  It's the plan's responsibility to maintain its tax-advantaged status.  Claims must be substantiated by an independent third-party.  The plan's failure to properly substantiate claims could result in loss of the safe harbor from constructive receipt, causing all contributions to be taxable for all employees.

Here's a short summary from a recent IRS memorandum--

https://www.irs.gov/pub/irs-wd/202317020.pdf

If a section 125 cafeteria plan does not require an independent third party to fully substantiate reimbursements for medical expenses (for example, by permitting self-certification of expenses, “sampling” of expenses, or certification by favored providers), does not require substantiation for medical expenses below certain dollar amounts, or does not substantiate reimbursements for dependent care assistance expenses, then the plan fails to operate in accordance with the substantiation requirements of Prop. Reg. § 1.125–6(b) and is not a cafeteria plan within the meaning of section 125. Therefore, the amount of any 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.

Here are the relevant cites--

Prop. Treas. Reg. §1.125-6:

(b) Rules for claims substantiation for cafeteria plans.

(1) Substantiation required before reimbursing expenses for qualified benefits. This paragraph (b) sets forth the substantiation requirements that a cafeteria plan must satisfy before paying or reimbursing any expense for a qualified benefit.

(2) All claims must be substantiated. As a precondition of payment or reimbursement of expenses for qualified benefits, a cafeteria plan must require substantiation in accordance with this section. Substantiating only a percentage of claims, or substantiating only claims above a certain dollar amount, fails to comply with the substantiation requirements in §1.125-1 and this section.

(3) Substantiation by independent third-party.

(i) In general. All expenses must be substantiated by information from a third-party that is independent of the employee and the employee's spouse and dependents. The independent third-party must provide information describing the service or product, the date of the service or sale, and the amount. Self-substantiation or self-certification of an expense by an employee does not satisfy the substantiation requirements of this paragraph (b). The specific requirements in sections 105(b), 129, and 137 must also be satisfied as a condition of reimbursing expenses for qualified benefits. For example, a health FSA does not satisfy the requirements of section 105(b) if it reimburses employees for expenses where the employees only submit information describing medical expenses, the amount of the expenses and the date of the expenses but fail to provide a statement from an independent third-party (either automatically or subsequent to the transaction) verifying the expenses. Under §1.105-2, all amounts paid under a plan that permits self-substantiation or self-certification are includible in gross income, including amounts reimbursed for medical expenses, whether or not substantiated. See paragraph (m) in §1.125-5 for additional substantiation rules for limited-purpose and post-deductible health FSAs.

Prop. Treas. Reg. §1.125-1:

(7) Operational failure.

(i) In general. If the cafeteria plan fails to operate according to its written plan or otherwise fails to operate in compliance with section 125 and the regulations, the plan is not a cafeteria plan and employees' elections between taxable and nontaxable benefits result in gross income to the employees.

(ii) Failure to operate according to written cafeteria plan or section 125. Examples of failures resulting in section 125 not applying to a plan include the following—

(A) Paying or reimbursing expenses for qualified benefits incurred before the later of the adoption date or effective date of the cafeteria plan, before the beginning of a period of coverage or before the later of the date of adoption or effective date of a plan amendment adding a new benefit;

(B) Offering benefits other than permitted taxable benefits and qualified benefits;

(C) Operating to defer compensation (except as permitted in paragraph (o) of this section);

(D) Failing to comply with the uniform coverage rule in paragraph (d) in §1.125-5;

(E) Failing to comply with the use-or-lose rule in paragraph (c) in §1.125-5;

(F) Allowing employees to revoke elections or make new elections, except as provided in §1.125-4 and paragraph (a) in §1.125-2;

(G) Failing to comply with the substantiation requirements of § 1.125-6;

(H) Paying or reimbursing expenses in an FSA other than expenses expressly permitted in paragraph (h) in §1.125-5;

(I) Allocating experience gains other than as expressly permitted in paragraph (o) in §1.125-5;

(J) Failing to comply with the grace period rules in paragraph (e) of this section; or

(K) Failing to comply with the qualified HSA distribution rules in paragraph (n) in §1.125-5.

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