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When FSA Expenses are Incurred

Question:  When are FSA expenses incurred for purposes of determining whether they are reimbursable for the plan year?

Short Answer: FSA expenses are considered incurred when the health care or dependent care services are actually provided.

General Rule: Expenses Must be Incurred in the Period of Coverage

An FSA can reimburse only expenses incurred during the participant’s period of coverage.  The period of coverage is the period of the FSA plan year in which the employee is enrolled (including any grace period for such plan year).

This means that any expenses incurred before or after the employee’s FSA period of coverage are not reimbursable.

Allowing an expense incurred outside the period of coverage to be reimbursed by the FSA would be a plan operational failure.  The Section 125 regulations provide that operational failures can result in the entire Section 125 cafeteria plan being disqualified if discovered by the IRS—which would result in all cafeteria plan elections becoming taxable for all employees.

Example 1:

  • Tim incurs $240 in glasses expenses in March 2020.
  • Tim changes jobs and is a new hire with a new employer in May 2020.
  • The new employer maintains a calendar plan year health FSA.
  • Tim enrolls in the health FSA, making a $1,000 election for coverage beginning June 2020 through the end of the plan year.

Result 1:

  • Tim’s March 2020 glasses expenses are not reimbursable under the FSA because the expenses were incurred prior to his period of coverage.
  • Only health expenses incurred from June through December 2020 (plus any associated grace period) are within his period of coverage for the 2020 plan year.

Example 2:

  • Matt is not enrolled in his employer’s 2020 calendar plan year health FSA.
  • Matt makes a $1,000 health FSA election at open enrollment for the 2021 plan year.
  • Matt incurs $125 in contact lenses expenses in December 2020.

Result 2:

  • Matt’s contact lenses expenses are not reimbursable under the FSA because the expenses were incurred prior to his period of coverage.
  • Only health expenses incurred from January through December 2021 (plus any associated grace period) are within his period of coverage for the 2021 plan year.

For details on expenses incurred after termination of participation, see our previous posts:

FSA Expenses are Incurred When the Services are Provided

The FSA rules provide that an expense is considered incurred when the health care or dependent care services are provided.

In other words, the expense is not incurred when the employee is billed, charged, or pays for the care.  Rather, the expense is incurred (and therefore reimbursable) only when the actual service is performed.

Example 3:

  • Madison undergoes a shoulder procedure in March 2020.
  • Madison changes jobs and is a new hire with a new employer in May 2020.
  • The new employer maintains a calendar plan year health FSA.
  • Madison enrolls in the health FSA making a $1,000 election for coverage beginning June 2020 through the end of the plan year.
  • In June 2020, Madison receives an EOB confirming he owes $375 in deductible expenses for the procedure.
  • In August 2020, Madison pays the $375 deductible expense to his medical provider.

Result 3:

  • Madison’s deductible expense is considered incurred in March 2020.
  • The March 2020 expense is not reimbursable under the FSA because the expense was incurred prior to his period of coverage.
  • Only health expenses incurred from June through December 2020 (plus any associated grace period) are within his period of coverage for the 2020 plan year.
  • The fact that Madison was billed and paid for the expense during the period of coverage is not relevant for determining when the expense was incurred.

Example 4:

  • Barry is not enrolled in his employer’s 2020 calendar plan year health FSA.
  • Barry makes a $1,000 health FSA election at open enrollment for the 2021 plan year.
  • Barry has a mental health therapy session in December 2020.
  • In January 2021, Barry receives an EOB confirming he owes an $45 copayment for the session.
  • In February 2022, Barry pays the $45 copayment to the mental health provider.

Result 4:

  • Barry’s therapy copayment is considered incurred in December 2020.
  • The December 2020 expense is not reimbursable under the FSA because the expense was incurred prior to his period of coverage.
  • Only health expenses incurred from January through December 2021 (plus any associated grace period) are within his period of coverage for the 2021 plan year.
  • The fact that Barry was billed and paid for the expense during the period of coverage is not relevant for determining when the expense was incurred.

For details on expenses incurred after termination of participation, see our previous posts:

Exception: Orthodontia Pre-Payment

A health FSA is permitted (but not required) to permit orthodontia expense pre-payments to be considered incurred at the point of advance payment—prior to the orthodontia services being performed.

The employee must actually make the advance payment for the orthodontia expense to be considered incurred.  The employee’s receipt of a bill for pre-payment of the services does not by qualify without the employee’s actual pre-payment.

The IRS permits this exception to the general rule (i.e., that expenses be considered incurred only when the services are performed) because of the prevalence of pre-payment requirements for orthodontia services.

Example 5:

  • Jonathan is enrolled in his employer’s 2020 calendar plan year health FSA.
  • In November 2020, Jonathan’s orthodontist sends a $2,500 bill for the required pre-payment of orthodontia services to be performed throughout 2021.
  • In December 2020, Jonathan makes full payment of the $2,500 bill to pre-pay for the 2021 orthodontia services.

Result 5:

  • The employer’s health FSA may treat Jonathan’s pre-payment of the orthodontia expense in December 2020 as the date in which he incurred the expense.
  • Jonathan can therefore submit the $2,500 expense for reimbursement to his 2020 plan year health FSA.
  • This is the exception to the general rule that Jonathan would be considered to incur the expenses only in 2021 when the services are performed.

For full details on all of the key Section 125 cafeteria plan issues for employers, see our ABD Office Hours Webinar: Section 125 Cafeteria Plans.

Regulations

Prop. Treas. Reg. §1.125-5(a)(1):

(a) Definition of flexible spending arrangement.

(1) In general. In general. An FSA generally is a benefit program that provides employees with coverage which reimburses specified, incurred expenses (subject to reimbursement maximums and any other reasonable conditions). An expense for qualified benefits must not be reimbursed from the FSA unless it is incurred during a period of coverage. See paragraph (e) of this section. After an expense for a qualified benefit has been incurred, the expense must first be substantiated before the expense is reimbursed. See paragraphs (a) through (f) in §1.125-6.

Prop. Treas. Reg. §1.125-6(a)(2):

(2) Expenses incurred.

(i) Employees’ medical expenses must be incurred during the period of coverage. In order for reimbursements to be excludible from gross income under section 105(b), the medical expenses reimbursed by an accident and health plan elected through a cafeteria plan must be incurred during the period when the participant is covered by the accident and health plan. A participant’s period of coverage includes COBRA coverage. See §54.4980B-2 of this chapter. Medical expenses incurred before the later of the effective date of the plan and the date the employee is enrolled in the plan are not incurred during the period for which the employee is covered by the plan. However, the actual reimbursement of covered medical care expenses may be made after the applicable period of coverage.

(ii) When medical expenses are incurred. For purposes of this rule, medical expenses are incurred when the employee (or the employee’s spouse or dependents) is provided with the medical care that gives rise to the medical expenses, and not when the employee is formally billed, charged for, or pays for the medical care.

(iii) Example. The following example illustrates the rules in this paragraph (a)(2):

Example. Medical expenses incurred after termination.

(i) Employer E maintains a cafeteria plan with a calendar year plan year. The cafeteria plan provides that participation terminates when an individual ceases to be an employee of Employer E, unless the former employee elects to continue to participate in the health FSA under the COBRA rules in §54.4980B-2 of this chapter. Employee G timely elects to salary reduce $1,200 to participate in a health FSA for the 2009 plan year. As of June 30, 2009, Employee G has contributed $600 toward the health FSA, but incurred no medical expenses. On June 30, 2009, Employee G terminates employment and does not continue participation under COBRA. On July 15, 2009, G incurs a section 213(d) medical expense of $500.

(ii) Under the rules in paragraph (a)(2) of this section, the cafeteria plan is prohibited from reimbursing any portion of the $500 medical expense because, at the time the medical expense is incurred, G is not a participant in the cafeteria plan.

Prop. Treas. Reg. §1.125-6(a)(4)(i):

(4) Reimbursements of dependent care expenses.

(i) Dependent care expenses must be incurred. In order to satisfy section 129, dependent care expenses may not be reimbursed before the expenses are incurred. For purposes of this rule, dependent care expenses are incurred when the care is provided and not when the employee is formally billed, charged for, or pays for the dependent care.

Prop. Treas. Reg. §1.125-6(b)(4):

(4) Advance reimbursement of expenses for qualified benefits prohibited. Reimbursing expenses before the expense has been incurred or before the expense is substantiated fails to satisfy the substantiation requirements in §1.105-2, §1.125-1 and this section.

Prop. Treas. Reg. §1.125-5(k)(3)

(3) Application of prohibition against deferred compensation to medical expenses.

(i) Certain advance payments for orthodontia permitted. A cafeteria plan is permitted, but is not required to, reimburse employees for orthodontia services before the services are provided but only to the extent that the employee has actually made the payments in advance of the orthodontia services in order to receive the services. These orthodontia services are deemed to be incurred when the employee makes the advance payment. Reimbursing advance payments does not violate the prohibition against deferring compensation.

(ii) Example. The following example illustrates the rules in paragraph (k)(3):

Example. Advance payment to orthodontist. Employer D sponsors a calendar year cafeteria plan which offers a health FSA. Employee K elects to salary reduce $3,000 for a health FSA for the 2009 plan year. Employee K’s dependent requires orthodontic treatment. K’s accident and health insurance does not cover orthodontia. The orthodontist, following the normal practice, charges $3,000, all due in 2009, for treatment, to begin in 2009 and end in 2010. K pays the $3,000 in 2009. In 2009, Employer D’s cafeteria plan may reimburse $3,000 to K, without violating the prohibition against deferring compensation in section 125(d)(2).

(iii) Reimbursements for durable medical equipment. A health FSA in a cafeteria plan that reimburses employees for equipment (described in section 213(d)) with a useful life extending beyond the period of coverage during which the expense is incurred does not provide deferred compensation. For example, a health FSA is permitted to reimburse the cost of a wheelchair for an employee.

Prop. Treas. Reg. §1.125-1(c)(7)(ii)(G):

(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.


About the author

Brian Gilmore

Brian Gilmore is the Lead Benefits Counsel at Newfront. He assists clients on a wide variety of employee benefits compliance issues. The primary areas of his practice include ERISA, ACA, COBRA, HIPAA, Section 125 Cafeteria Plans, and 401(k) plans. Brian also presents regularly at trade events and in webinars on current hot topics in employee benefits law.


The information provided is of a general nature and an educational resource. It is not intended to provide advice or address the situation of any particular individual or entity. Any recipient shall be responsible for the use to which it puts this document. Newfront shall have no liability for the information provided. While care has been taken to produce this document, Newfront does not warrant, represent or guarantee the completeness, accuracy, adequacy, or fitness with respect to the information contained in this document. The information provided does not reflect new circumstances, or additional regulatory and legal changes. The issues addressed may have legal, financial, and health implications, and we recommend you speak to your legal, financial, and health advisors before acting on any of the information provided.

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