Many businesses now offer, as part of their health care benefits, various types of accounts that reimburse employees for medical expenses on a tax-advantaged basis. These include health Flexible Spending Accounts (FSAs), Health Reimbursement Arrangement (HRAs) and Health Savings Account (HSAs). Offerings for HSAs are usually in conjunction with a high-deductible health plan.
For employees to get the full value out of such accounts, they need to educate themselves. Employees need to know what expenses are eligible for reimbursement by a health FSA or HRA, or for a tax-free distribution from an HSA. Generally an an employer should not provide tax advice to employees. However, you can give them a heads-up that the rules for reimbursements or distributions vary depending on the type of account.
Unfortunately, no single publication provides an exhaustive list of official, government-approved expenses eligible for reimbursement by a health FSA or HRA, or for a tax-free distribution from an HSA. IRS Publication 502 — “Medical and Dental Expenses” (Pub 502) comes the closest, but it should be used with caution.
Pub 502 is largely available to help taxpayers determine what medical expenses are deductible on their income tax returns. However, the publication is not meant to address the tax-favored health care accounts in question. Although the rules for deductibility overlap in many respects with the rules governing health FSAs, HRAs and HSAs, there are some important differences. Thus, employees shouldn’t use Pub 502 as the sole determinant for whether an expense is reimbursable by a health FSA or HRA, or eligible for tax-free distribution from an HSA.
You might warn health care account participants that various factors affect whether and when a medical expense is reimbursable or a distribution allowable. These include:
Publication 502 notes that deductions on expenses may be are applicable only for the year in which they were paid. However, it doesn’t explain the different timing rules for the tax-favored accounts. For example, a health FSA can reimburse an expense only for the year in which it was incurred, regardless of when it was paid.
When taxpayers meet certain requirements, they may deduct health insurance premiums on their tax returns. However, reimbursement of such premiums by health FSAs, HRAs and HSAs is subject to restrictions that vary according to the type of tax-favored account.
OTC drugs other than insulin aren’t tax-deductible. However, a reimbursement may still be possible by health FSAs, HRAs and HSAs if the employee meets the substantiation and other requirements. Click here for additional HRA, HSA and FSA comparisons.
The pandemic has put a renewed emphasis on the importance of employer-provided health care benefits. The federal government has even passed COVID-19-related relief measures for some tax-favored accounts.
As mentioned, the more that employees understand these benefits, the more they’ll be able to effectively use them. Plus, they’ll have a greater appreciation they’ll have of your business for providing them. Our accounting firm can help you fully understand the tax implications, for both you and employees, of any type of health care benefit.