California Mandates on the Flexible Spending Account (FSA)

One of the top reasons for bankruptcy in the United States is unpaid medical bills. Medical costs are also one of the top stressors for Americans.

Fortunately, medical insurance provides peace of mind by mitigating financial risks and burdens associated with healthcare costs. However, medical insurance has its limitations and exclusions as to what it will cover. It isn’t uncommon for plans to exclude certain services or limit the amount it is willing to pay for services that doctors might deem appropriate for a patient’s well-being, such as chiropractic care. Also, medical insurance traditionally does not pay for health maintenance care, such as vitamins and over-the-counter medications.

Plan participants typically have to meet deductibles, pay copays, and their coinsurance portion, even with the best of insurance options. Health insurance plans with high deductibles equate to the plan participant having to meet that deductible out-of-pocket before co-insurance kicks in.

A Flexible Spending Account (FSA) can help cover some of the medical expenses that medical insurance does not cover. 

Below is a break down of the different types of accounts and how California law applies to them

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WHAT IS A FLEXIBLE SPENDING ACCOUNT?

Traditional health insurance plans are typically accompanied by FSAs. A flexible spending account is a tax-deferred account to help pay for qualifying medical expenses. Employees can contribute funds up to the IRS annual maximum per year into the account tax-free.

Qualified medical expenses include prescriptions, copays, chiropractor visits, and other necessary healthcare expenses. When selecting the FSA option during benefits enrollment, the employee sets his or her annual contribution amount at that time. The amount is typically divided by the number of pay periods in a year, and that amount is withdrawn from each paycheck.

Employees are permitted to borrow against the amount they allotted to contribute to their FSA throughout the year. If employees do not use the funds deposited into their FSA for the plan year, the money is forfeited, which is commonly referred to as the “use it or lose it” aspect of an FSA.

On the other hand, if an employee has spent more than what was deposited into their account prior to their termination, there is no legal requirement for the money to be paid back as long as it was used towards eligible expenses. Employers have the option to ask the employee to repay the funds, though it can be difficult to get the employee to repay the money. On the other hand, the employer comes out ahead when the employee forfeits funds contributed to their FSA at the end of the year.

COVID-19 RELATED FSA CHANGES

Due to COVID-19, the IRS has modified FSA rules to provide more flexibility. For 2020 only, employers are permitted to grant employees the option to stop, change, or start their health care or dependent care FSA contribution amounts mid-year without a qualifying event which is typically required to make such changes. Employers can also extend plan years or grace periods scheduled to end at some point in 2020.

The list of qualifying reimbursable expenses has also been expanded due to COVID-19. Over-the-counter medications without a doctor’s prescription and menstrual products are now reimbursable with FSA contributions. This rule is retroactive to the beginning of 2020 and a permanent change beyond the COVID-19 emergency.

WHAT TYPE OF FLEXIBLE SPENDING ACCOUNTS ARE AVAILABLE

There are four common types of flexible spending accounts available:

• Health Care
• Dependent Care
• Limited Purpose
• Adoption Assistance

HEALTH CARE FSA

A health care flexible spending account is a self-insured welfare benefit available under the Employee Retirement Income Security Act (ERISA). A health care FSA applies to the primary healthcare participant or employee covered under the insurance plan. The annual IRS contribution limit for a health care FSA in 2020 and 2021 is $2,750.

Depending on the employer’s preference, it is possible to carry over a portion of a health care FSA into the next plan year. An employee could carry over $500 from their 2019 to 2020 FSA. The rollover amount increased by $50 for 2020, so an employee can carry over $550 from their 2020 FSA to their 2021 FSA.

DEPENDENT CARE FSA

A dependent care FSA is a welfare benefit option that employees can select to cover care for their qualifying dependents, including children under 13 years of age and adult dependents who cannot take care of themselves. Similar spending and withdrawal rules apply to a dependent care FSA as they do to a health care FSA.

The annual IRS contribution limit for a dependent care FSA in 2020 and 2021 is $5,000. If two spouses both have dependent care FSAs, the total combined FSA contribution limit for the family is $5,000 for the two dependent care FSAs combined.

LIMITED PURPOSE FSA

A limited-purpose FSA allows you to contribute to both a Health Savings Account (HSA) and FSA. However, the only type of expenses a limited purpose FSA can cover are dental and vision expenses.

If an employer offers a limited purpose FSA, it is generally wise for employees to opt-in. A limited-purpose FSA allows them to reserve more of the funds contributed to an HSA for savings, retirement, and qualifying medical expenses outside of dental and vision expenses. The IRS annual contribution limit for a limited-purpose FSA is the same as it is for a healthcare FSA: $2,750.

ADOPTION ASSISTANCE FSA

An adoption assistance FSA allows reimbursement on a pre-tax basis for reasonable and necessary expenses associated with a legal adoption. Reimbursable expenses include court costs, adoption fees, attorney fees, and travel costs.

The child must be under 18 or not capable of mentally or physically caring for himself or herself. The maximum contribution limit for 2020 is $14,300 for an adoption assistance FSA when the adjusted gross income of the filers does not exceed $214,520. The allowable pre-tax reimbursement amount is adjusted downward using a standard formula if the adjusted gross income exceeds that amount.

CALIFORNIA LAW FLEXIBLE SPENDING ACCOUNT REQUIREMENTS

The state of California has specific mandates regarding flexible spending accounts. As of January 1, 2020, California law AB 1554, Section 2810.7 requires employers to notify employees of FSA withdrawal deadlines that explain the “use it or lose it” federal tax rules of an FSA. AB 1554 applies to health, dependent care, and adoption assistance flexible spending accounts. 

The California law requires employers to provide notification to employees whose FSA coverage terminates during the plan year, which creates a shortened period for the employee to use their funds before they lose them. Interpretation of the law also indicates that it refers to any money remaining in the FSA at the end of a plan year that would need to be spent before year-end. However, the law does not indicate when the communications should occur.

Per the law, employers must notify employees of “any deadline to withdraw funds before the end of the plan year,” using two different communication methods. A presumed goal of the law is to ensure that employees are clear about the “use it or lose it” aspect about any funds remaining in their FSA account so they can avoid forfeiture of the funds.

The various communication methods that can be used include telephone, postal mail, email, text message, hard copy documents, or in-person notification. Only one of the forms of communication can be electronic, so the second form of communication must be printed or verbal.

LEGAL APPLICATION TO HEALTH CARE FSAS

The majority of health care flexible spending accounts are ERISA plans. Therefore, an ERISA preemption should apply to California’s employee notification requirement. If challenged by the state of California due to the state not recognizing the ERISA preemption, the employer can challenge any claims brought by the state.

Employers can also choose to voluntarily comply with the California law to avoid any legal battles with the state. Clearly explaining the forfeiture aspect of an FSA to employees is also a good practice for employers to apply, regardless of legal requirements.

If an event (e.g., change in employment status, termination of employment, etc.) causes an employee’s FSA coverage to terminate mid-year, a health care FSA will either apply the regular plan-year runout period or will require claims to be submitted within a shortened period of time. For example, the plan might state that employees have 60 to 90 days after coverage terminates to submit qualifying claims incurred before termination. This is the type of situation the California law specifically applies to.

When a health care FSA does not require claims to be filed during a shortened period after a mid-year termination, the plan participant typically has a period after December 31 (or whatever date is specified for the end of the plan year) to submit claims for reimbursement, similar to plan participants who are active throughout the entire plan year. In this case, the California notification law would not apply, as the law states a notification is required for “any deadline to withdraw funds before the end of the plan year.”

An ERISA preemption does not apply to government or church health care flexible spending accounts. Therefore, California employers should be sure they comply with the legal notification requirements set forth by the state.

LEGAL APPLICATION TO DEPENDENT CARE FSAS AND ADOPTION ASSISTANCE FSAS

Similar to government and church health care FSAs, or an ERISA, preemption does not apply to dependent care and adoption assistance FSAs. Therefore, California employers will need to comply with the California FSA legal notification requirements when applicable.

Unlike health care FSAs, dependent care FSAs typically do not have a shortened period to use funds after a mid-year termination. The IRS also permits dependent care FSA contributions to be used towards qualifying expenses incurred after termination through to the end of the plan year. For these reasons, the California law requiring the notification would not apply to most dependent care FSAs.

LEGAL COMPLIANCE CONCERNS AND OPTIONS

For FSAs that do not fall under the ERISA preemption and impose a shortened claims runout period due to mid-year termination, the California notification law applies. However, since the law does not indicate when the two forms of notification should be provided, it is possible that many plans already satisfy the requirement.

For instance, most plan documents or summary plan descriptions include information about the shortened claims runout period and forfeiture of funds disclosure. This would satisfy one of the two required communications. Other possible forms of communication that include such information could be:

• An annual open enrollment guide.
• A one-on-one conversation with a plan representative.
• Email newsletter.
• Documentation provided on the FSA administrator’s website.
• Information provided on the company’s employee benefits website.
• Enrollment confirmation documentation mailed to the employee.

It is important to clarify that the California law applies to the requirements for withdrawing funds before the end of the plan year. An employer or FSA plan sponsor could opt to eliminate any shortened runout period for mid-year FSA terminations. In this instance, only the annual runout period would apply, which does not require two types of withdrawal communication notification to be provided to plan participants, since they would time beyond the end of the year to submit claims. In other words, a plan with an annual runout period for mid-year terminations would eliminate the need to comply with the California FSA notification rule.

KBI IS IN THE KNOW AS YOUR BENEFITS BROKER

State employee health and welfare benefit requirements sometimes differ from federal requirements. It is important to understand both when you’re an employer to ensure you’re providing the minimum level of coverage required for your employees. You also want to ensure you’re meeting legal reporting and regulatory requirements.

As an employee, you want to know you are receiving, at a minimum, the level of benefits required by law. You also want to know you and your family are protected and can meet the financial requirements of adequate healthcare.

Flexible spending accounts provide a means to cover healthcare expenses tax-free. With the many FSA plans available, having the best plan to accompany your healthcare plan is important. Individuals also need to understand the best way to utilize an FSA plan to maximize savings without forfeiting funds at the end of the plan year.

As your local, reputable benefits broker, KBI can help with all of the items mentioned above. Our job is to know the ins and outs of benefits plans and options to ensure you have the best plans to meet your needs, including flexible spending accounts. We also have relationships with numerous benefit providers, so we can shop around to find healthcare plan options to meet your needs and budget.

As your benefits broker, we are here to help you navigate the California laws.