IRS Memorandum Outlines Considerations for Substantiating FSA Expenses

IRS publication reviews the requirements for substantiating medical expenses from a health FSA and outlining scenarios where improper substantiation causes cafeteria plan compliance issues.

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June 07, 2023

On March 29, 2023, the Internal Revenue Service (IRS) Office of Chief Counsel published Memorandum #202317020, titled “Claims Substantiation for Payment or Reimbursement of Medical and Dependent Care Expenses.” The memorandum addresses a technical plan administration question regarding whether reimbursements of medical expenses under Section 213 of the Internal Revenue Code (Code) to an employee from a health flexible spending account (FSA) are included in an employee’s gross income if any of the medical expenses are not properly substantiated in accordance with the §125 cafeteria plan regulations.

Key Action

Review FSA claims substantiation scenarios with legal counsel, third-party administrators, and FSA carriers/vendors to compare established processes with IRS examples.

The memorandum outlines scenarios with different approaches to substantiating claims. The IRS first describes a comprehensive approach that complies with the respective Code requirements where a plan applies substantiation requirements such as requiring information from a third-party independent of an employee and their spouse or dependents and requiring third party-supplied information to include key information describing the service or product, date. The IRS then describes other scenarios where a plan would fail to satisfy the Code’s substantiation requirements requiring that the medical expenses be included in an employee’s gross income and taxable wages. These include:

  • If the plan relies on employees’ self-certification of expenses;
  • If the plan substantiates only a sampling of some expenses;
  • If the plan requires claims amounts over a certain level (i.e., de minimis amounts) to be substantiated; and
  • If charges from favored providers are not required to be substantiated.

The memorandum also addresses whether a plan may allow reimbursement of dependent care FSA expenses before the expenses are incurred, concluding that prospective reimbursement fails to satisfy the Code’s substantiation requirements under §§125 and 129 and thus must be incldued in an employee’s gross income and taxable wages.

The memorandum also addresses whether a plan may allow reimbursement of dependent care FSA expenses before the expenses are incurred, concluding that prospective reimbursement fails to satisfy the Code’s substantiation requirements under §§125 and 129 and thus must be incldued in an employee’s gross income and taxable wages.

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If you have questions, comments, or concerns about these or other regulatory and compliance issues, please contact us.

We provide this material for informational purposes only; it is not a substitute for legal advice.

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