Does a Health FSA reimburse medical expenses in the year when they are paid or in the year when the expense is incurred?
A Health FSA reimburses medical expenses in the year they are incurred, not when they are paid. This is in contrast to individual tax deductions for medical expenses, which are claimed in the year they are paid. IRS Publication 502 explains that medical expenses should be deducted when paid, regardless of the time when services were rendered. Generally, medical expenses are deductible only if they exceed 10% of the taxpayer's adjusted gross income. According to IRS regulations, Health FSA reimbursements are tied to the year in which the expenses are incurred, and they must occur while the participant is covered by the plan. There are exceptions to this rule, including the "Grace Period" and rollover provisions, which allow for certain extended use of FSA funds.
Deducting Medical Expenses on a Tax Return
IRS Publication 502 clarifies that individuals are “tax basis” taxpayers and should deduct medical expenses when paid regardless of when the services are provided.
“You can include only the medical and dental expenses you paid this year, regardless of when the services were provided.” (IRS Publication 502, page 2)
Please note that in most cases medical expenses are only deductible to the extent they exceed 10% of the taxpayer’s adjusted gross income.
Reimbursement of Expenses from a Health FSA
IRS regulations make it clear that employees participating in a Health FSA may only be reimbursed for expenses in the year they are incurred.
"Employees' medical expenses must be incurred during the period of coverage. In order for reimbursements to be excludable from gross income, the medical expenses reimbursed by a Health FSA elected through a cafeteria plan must be incurred during the period when the participant is covered by the Health FSA.
For purposes of this rule, medical expenses are incurred when the employee 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." (Reg. 1.15-6(a)(2).)
Expenses reimbursed through a Health FSA are only reimbursed when incurred.
Can FSA funds contributed in the current plan year be used for expenses incurred in the prior year but paid for in the current year?
No. All individuals are “cash basis taxpayers” meaning they deduct medical expenses on their tax return in the year they pay for the expenses. However, a Health Flexible Spending Account (FSA) works differently. FSA contributions can only be used to pay for expenses when the services are provided or items are purchased in the same year as the contributions.
IRS Regulations state:
“Employees' medical expenses must be incurred during the period of coverage. In order for reimbursements to be excluded 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.”
Are there any exceptions?
Yes, there are two exceptions to the rule. An employer must adopt the exception:
- If the plan has adopted a “Grace Period," in which participants may use contributions from one year to pay for services provided for up to 2 1/2 months after the end of the year.
- If the plan has adopted the rollover provisions, which allows participants to roll over up to $570 (2022 plan year rollover limit; $610 for 2023 plan years) of unused money at the end of the year.