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Tax-exclusion limits for commuting and adoption benefits also edge up
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updated on Dec. 26, 2017
For 2018, employees can contribute $2,650 to their health FSAs, up from the 2017 limit of $2,600. The increase also applies to limited-purpose FSAs that are restricted to dental and vision services.
Just in time for open enrollment season, the IRS made the change in
Revenue Procedure 2017-58, issued Oct. 19.
Other inflation-adjusted benefits caps will also increase, if only slightly, such as for qualified transportation benefits and adoption assistance programs.
The increase in the cost-of-living index—up 2.2 percent for the 12 months ending in September, was enough to meet the statutory thresholds that trigger rate adjustments for these benefits.
Employers should communicate the higher cap to employees during open enrollment and include the new limit in their open-enrollment materials—even if they must, at this late date, do so through a printed or online addendum.
"Once again, the IRS delivers their FSA maximum limit changes too late for many employers to adjust their printed communications," said Brian Uhlig, Chicago-based senior vice president for benefits consulting at GCG Financial, part of Alera Group, a network of insurance and financial services firms."
"Employers should ensure that their health care FSA will not allow employees to make pretax contributions in excess of $2,650 for 2018, and they should communicate the 2018 limit to their employees as part of the open enrollment process," said Steven Costello, principal and co-founder of CBG Benefits, an employee benefits brokerage and service provider headquartered in Woburn, Mass.
"Of course, employers are not required to change the contribution limit on their plan," he noted.
Employee and Employer FundingHealth FSAs can be funded on a pretax basis by employees, employers or both. The new $2,650 limit applies to employee pretax salary reduction contributions to either a full-purpose or a limited-purpose health FSA.
"Employer contributions generally do not count toward the limit,"
noted Janet Stebbins, a benefit analyst with Marsh Consulting Group in Paso Robles, Calif. "However, if the employer contribution is a result of the employee’s use of cafeteria plan flex credits which he/she may have otherwise elected to receive in cash or as a taxable benefit, then the contribution would count towards the $2,650 limit."
While FSA contribution caps for employees "are routine and well understood by employers and employees alike, many employers may not be aware of regulations regarding employer contributions to their employees' FSAs," said Harrison Stone, general counsel and compliance officer at ConnectYourCare, a benefits administration firm based in Baltimore.
He noted, for instance, that to remain an "excepted benefit" not subject to Affordable Care Act requirements that apply to group health plans, employer contributions to the health FSA may not be more than double the employee's salary reduction contribution or, if the employee's contribution is less than $500, then not more than $500.
For example, "an employee who contributes $1,000 could receive only up to a $1,000 match from his or her employer, while an employee who contributes $350 could receive up to $500 from his or her employer," Stone explained.
"Technically, there is no set maximum for employer contributions to an FSA," added Jeremy Miller, CEO and founder of FSAstore.com, an e-commerce site. However, "employers will typically limit their contributions to no more than $500 or to a match of the employee contribution, up to the 2018 limit of $2,650. This makes it easier for the FSA to meet certain Affordable Care Act requirements and easier for employers to administer," he observed.
Funds in an FSA can pay for medical services under the health plan's deductible and can be used for health insurance co-payments. "Some over-the-counter (OTC) medications can be purchased with FSA dollars but require a doctor's prescription to do so, while other OTC items do not," said Ijeoma Iruke, consumer education specialist at FSAstore.com.
Unspent FundsSince 2013, there have been
two options for handling unused funds in a health FSA at year-end that employers can adopt:
"Health FSAs cannot have both a carryover and a grace period option, and employers are not obligated to offer either extension," Miller said A plan must be amended to implement either feature, he noted.
Differences with HSAs
During open enrollment, employees are often
confused about the differences between health FSAs and health savings accounts (HSAs), which have
higher annual contribution limits and allow unused funds to remain and grow within the account from year to year, among other distinctions. When both FSAs and HSAs are benefit options, open-enrollment communications should clearly state how the two differ, using a side-by-side list of account features, for instance.
An individual who is covered by a general-purpose health FSA is not eligible to contribute to an HSA. This holds true even if the individual is covered by a health FSA sponsored by a spouse's employer. However, an individual may contribute to both an HSA and a limited-purpose FSA that's restricted to dental and vision-care expenses.
Limited-purpose FSA funds can only be used to pay for qualifying dental and vision expenses incurred by employees or their covered spouses and qualified tax dependents. The contribution caps for a limited-purpose FSA are the same as for a health FSA. If employees are eligible for a health FSA, there's no reason for them to have a limited-purpose FSA, since the health FSA covers the services of a limited-purpose FSA (dental and vision).
Modifying Plan Documents
Consider writing your plan documents to define the contribution limit as the annual amount allowed by the IRS for the plan year, so that annual amendments are not necessary to permit contributions up to the adjusted pretax limit, Uhlig advised.
Otherwise, he noted, FSA plan sponsors can "simply make the adjustment next year."
"Employers are not required to adopt the new limit," noted Stebbins. "If they do, they may need to update their Section 125 cafeteria plan document and inform their third-party administrator if FSA administration is outsourced."
Open Enrollment TipsFor those able to modify their open enrollment communications, "this is a great opportunity for employers to encourage employees to not only sign up for an FSA account but take advantage of the increase in the annual limit," said Iruke.
She recommended that open enrollment materials give examples on how saving with an FSA can reduce out-of-pocket costs, such as: "If your annual salary next year is $60,000 and you elect to max out your FSA at $2,650, you will only be taxed on $57,350 instead of the full $60,000, while the $2,650 in your FSA is available to use to purchase qualifying items and services tax-free."
Younger employees are likely to say, "I don't get sick and I don't think I'll need this," Iruke added. When participants access an FSA calculator and enter their estimated co-pays, deductibles, prescriptions and other items that might not realize are eligible—such as prescription sunglasses—"they are able to get a better idea of how FSAs can work for them," she pointed out.
[SHRM members-only toolkit:
Designing and Managing Flexible Benefits (Cafeteria) Plans}
The dependent care FSA maximum is set by statute and is not subject to inflation-related adjustments. These limits have not been raised in several years.
A dependent care FSA is a pretax benefit account used to pay for dependent care services such as day care, preschool, summer camps and nonemployer-sponsored before or after school programs. Funds may be used for expenses relating to children under the age of 13 or incapable of self-care who live with the account holder more than half the year.
Dependent care FSAs also can be used for a spouse or other qualifying dependent who is physically or mentally incapable of self-care and lives with the account holder for more than half the year. They may be used for elder daycare when an elderly or disabled parent is considered a dependent and the account holder is covering more than 50 percent of the elderly or disabled parent's maintenance costs.
The annual contribution limit for a dependent Care FSA is based on the account holder's tax filing status. Generally, joint filers have double the limit of single or separate filers. However, even if each spouse has access to a separate FSA through his or her employer, they are still subject to the mandated maximum limits.
In addition, maximum contributions to a dependent FSA may not exceed these earned income limits:
Update: Final Tax Bill Preserves Dependent Care FSAs
Although an early version of the tax bill enacted at the end of 2017 would
have eliminated the tax exclusion for dependent care FSAs, the final version of the bill signed into law on Dec. 23 leaves the favorable tax treatment for dependent care FSAs in place.
Update: Tax Laws Scuttles Business Deductions for Transit Benefits
On Dec. 22, 2017,
President Donald Trump signed into law tax legislation that will eliminate the business deduction for
qualified mass transit and parking benefits.
Nonprofit employers aren't spared: Tax-exempt employers would be subject to the tax on unrelated business income for any qualified transportation benefits provided to employees.
Mass transit and parking benefits, however, will continue to be tax-exempt to employees, who can pay their own mass transit or workplace parking costs through an employer-sponsored program, using pretax income.
The tax law eliminates both the business deduction and employee tax exclusion on costs related to biking to work starting in 2018. The exclusion for biking benefits had been capped at $20 per month in both 2017 and 2018.
The monthly dollar limits for tax-excludable transit and parking benefits will inch up by $5 beginning in 2018.
"A lot of employees are asking, 'How do I make this commute into my office either less expensive or more efficient and convenient?'" said Dan Neuburger, president of WageWorks commuter services in San Mateo, Calif. Adding to this pressure is the growing number of cities and localities—including
New York City,
Washington, D.C., and
San Francisco—that are mandating that most employers offer these benefits on a tax-free basis, he said.
For employer-provided adoption assistance, the maximum amount excludable from an employee's income in 2018 vs. 2017 for the adoption of a child—both for regular and special-needs adoptions—is shown below. Excludable reimbursements are limited to "necessary and reasonable" expenses related to adopting a child.
For those with higher incomes, the adoption tax credit phases out. For 2018, those with adjusted gross incomes above $247,580 cannot claim the credit, while those with incomes from $207,580 to $247,580 can claim a portion of the credit.
* Originally set at $13,840 but subsequently recalculated by the IRS.** Originally set to begin phase-out at $207,580 and end phase-out at $247,580 but subsequently recalculated by the IRS.
"Adoption benefits typically include some combination of financial assistance, information and referral services, and paid or unpaid leave," according to the Society for Human Resource Management's toolkit,
Managing Adoption Assistance Benefits. "Adopting a child from foster care may cost about $2,500, domestic private adoptions can cost up to $40,000, and international adoptions can cost up to $30,000," the toolkit states. "Costs may include public or private agency fees, court costs, legal fees and counseling fees."
In addition to the employee benefit tax-exclusion limits noted above, federal agencies have also announced:
While the tax-free elements of a benefit program are important to most employees, they are only one part of a comprehensive benefits strategy. "Listen to your employees and find out what their needs are," said Julie Bond, program director for Best Workplaces for Commuters.
Employers should survey their workforce to see what benefits employees want and utilize. "It must be of value to employees because you don't want to set up a program that no one will use," she said.
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