How to Set Up an FSA (Flexible Spending Account): A Guide for Small Businesses

how to set up FSA for small business

Offering an FSA, or flexible spending account, as part of your benefits packages can be uniquely beneficial for both you and your employees. When implemented correctly, FSAs can help both the company and the insured save money on health care costs and pay less in taxes. How can you decide if this particular health care option is a good fit for your organization? Read on for a guide to the essentials of FSAs for small businesses, as well as information about how to set up an FSA if you choose to!


What is an FSA, Generally?


An FSA, or a flexible spending account, is an elective health benefit that is regulated by the federal government through the IRS. FSAs are commonly used to cover or reimburse employees for expenses that are not covered under the traditional group health insurance that is offered. Funds that have been contributed to an FSA are most likely to be withdrawn for costs such as co-pays, deductibles, care for dependents, or dental and vision.


Healthcare FSAs versus Dependent Care FSAs


There are two general types of FSAs, Healthcare FSAs and Dependent Care FSAs. Healthcare FSAs cover reimbursements for dental and vision expenses, copays, deductibles, medications, medical equipment, etcetera.


Dependent Care FSA funds are used for the purpose of covering expenses related to the care of children under age 13, the elderly, and dependents who cannot care for themselves. Funds from this type of FSA can go toward paying for childcare, including daycare outside the home or nannies/sitters inside the home. Dependent Care FSA funds cover an impressive array of expenses, including transportation to and from daycare. Employees can even be reimbursed if a relative is responsible for providing childcare, as long as that relative is not also a dependent of the employee. 


What are the Benefits of Setting Up a Healthcare FSA?


Besides the ability to help employees pay for out-of-pocket medical expenses and childcare, the provision of an FSA is particularly attractive because it helps alleviate the tax burden on both employees and employers. Contributions made to FSAs are made with pre-tax dollars.


On the employer side, the reduction in employee taxable income lowers overall employer payroll tax contributions. Employees also benefit, as they can save and use more money than they would have otherwise earned: when a portion of their wages goes into an FSA, their taxable income is reduced by the contributed amount.


How do Healthcare FSAs Work and How Can My Company Set Up a Healthcare FSA?


FSAs were established by the IRS for the purpose of offsetting the cost of medical care. For this reason, the IRS has allowed businesses to deduct a portion of an employee’s wages and put them into an FSA. Contributions to FSAs are limited annually by the IRS.


Any employee that chooses to participate in their employer’s FSA can decide how much of their salary they want to be contributed to the account for the upcoming benefits year. An employee can make this decision either when the FSA is started, when the employee first starts at the company, during an open enrollment period, or if the employee has experienced a qualifying life event such as a marriage, divorce, birth, or adoption of a child, or death of a spouse.


When an employee has enrolled in the FSA and has incurred out-of-pocket expenses, they submit claims to their employer for reimbursement. As long as the expense is qualified and doesn’t exceed any monetary limit the employer has set, they can be reimbursed for the expense.


It’s important to note that Healthcare FSAs have to carry a contribution of $2,750 for single employees as of 2021, and that limit will be raised to $2,850 for 2022. For married employees, the limit is generally about double. Similarly, the 2022 contribution cap for Dependent Care FSAs is $5,000 for married couples, but just $2,500 for single employees or those who are married and filing separately.


While employees cannot elect to add a greater amount of their salary to their FSA than these limits provide, they can always elect to contribute less.


Do FSA Funds Rollover?


For both Healthcare and Dependent Care FSAs, generally, funds not used during the year do not roll over. Companies can allow either a grace period of up to 90 days to use the funds, or they can also choose to allow up to $500 to roll over, but not more. Remember, however, this is an either/or choice: while the IRS does not require a company to offer either, it does forbid them from offering both. 


Healthcare FSA Compliance Considerations for Small Businesses:


Deciding to set up a Healthcare FSA for your employees brings a lot of benefits to all involved, but it’s not a decision free from a healthy amount of red tape. Setting up an FSA means your organization will be subject to new documentation requirements; for example, employers are required to provide a written plan document and summary plan description to all participating employees. Per the IRS, employers must also complete an annual nondiscrimination test during the plan year.


For small businesses, it’s also important to be aware that there is a distinction between General Purpose Health FSAs and Limited Purpose FSAs. General Purpose Health FSAs can be used to reimburse medical expenses defined under IRS section 213(d), which include deductibles, co-pays, prescriptions, eyeglasses, and orthodontia expenses. Limited Purpose FSAs can only be used to reimburse dental, vision, and preventive care expenses.


If you’re feeling confused about FSAs, whether you should offer them, and which employees you can or should offer them to, you’re not alone. The best decision for small businesses contemplating their health benefits package is always to consult with compliance experts before making any permanent choices.


Considering Offering an FSA to Your Employees?


After learning all about the unique advantages of FSAs for both your organization and your employees, you may be considering offering this type of benefit. When weighing the pros and cons, it always helps to talk to an expert, and Benely is here to help. Contact Benely for assistance in finding the perfect health coverage balance for your employees.