November 08, 2015

1. Cafeteria Plan: Employees are permitted to pay for their share of the cost of employerprovided health insurance on a pre-tax basis (free from income tax, social security and Medicare tax) if the employer has a section 125 cafeteria plan in place. The cafeteria plan is a written plan document that describes the administration and basic features of the plan.  The health insurance coverage purchased on a pre-tax basis under the cafeteria plan can cover the employee, the employee’ spouse and the employee’s dependents.   The portion of coverage paid for by the employer is a tax-free benefit to the employee.

2. Health Flexible Spending Account (FSA): A health flexible spending account (health FSA) is an optional component of a cafeteria plan that allows employees to pay for their share of uninsured medical or dental costs on a pre-tax basis.  Employees can set aside additional salary on a pre-tax basis to pay for uninsured medical costs of the employee, the employee’s dependents and the employee’s spouse (the employer can make contributions to the FSA account as well).  The health FSA is a written plan document that describes the administration and basic features of the plan.  An employee is permitted to contribute up to $2,500 of salary per year to a health FSA, increased periodically by the IRS for inflation.

For example, if an employer’s dental plan requires an employee to pay $1,000 out-ofpocket in order to get braces for his child, the employer could establish  health FSA in order to allow the employee to set aside the $1,000 of salary to pay for the braces on pretax basis.  The tax savings to the employee is significant.  For example, if the employee’s federal income tax rate is 25% and the employee is subject to FICA (7.65% combined), paying for the $1,000 deductible on a pre-tax basis through an FSA would save the employee $370.1  Similarly, the employer does not have to pay employment taxes on the salary contributed by the employee to the health FSA.

3. Health Savings Account (HSA): A Health Savings Account (HSA) is similar to an FSA however the HSA can only be established by an employee who is covered by a high deductible health plan (HDHP).  If the employee is covered under a non-HDHP of his/her spouse the employee is not eligible for coverage under a HAS.  For plans offering selfonly coverage, in order to be a HDHP the plan must have an employee deductible of between $1,250 and $6,350 (however coverage for certain preventative services can be provided without a deductible).  For plans offering coverage for the employee and at least one other individual, in order to be a HDHP the plan must have an employee deductible of between $2,500 and $12,700.  Both the employee and the employer can contribute to the HSA.  Employees can contribute salary to an HSA tax-free under an employer’s cafeteria plan or the employee can contribute his/her own outside funds. The total maximum amount that may be contributed to an HSA is $3,300 for individuals covered under a self-only plan and $6,550 for employees covered under all other plans, plus an additional $1,000 if the employee is at least 55 years old by the end of he plan year.  The employee can receive a tax deduction for contributions to an HSA and employer contributions can be tax-free.  Amounts contributed to an HSA are held by a qualifying trustee, usually a bank but not the emplyer, and rollover from year-to-year until the employee uses them.  The HSA is portable and travels with the individual even if he/she terminates employment.

4. Health Reimbursement Account (HRA): A Health Reimbursement Account (“HRA”) is a non-elective, employer-funded medical reimbursement plan that reimburses participants for eligible medical costs up to a prescribed dollar amount.  Reimbursements under an HRA are excluded from the participant’s income provided the HRA complies with applicable IRS guidelines.2  One major difference between a health FSA and an HRA is that a Health FSA can be funded with both employer and employee contributions, while an HRA is funded solely with employer contributions.  Another major difference between a Health FSA and an HRA is that an HRA can be used to reimburse employees tax-free for the cost of their health insurance premiums, while a health FSA cannot.  Also, as oppose to Health FSAs which have historically been subject to the “use it or lose it rule” discussed below, amounts remaining in HRAs at the end of the year can generally roll over and are available in later years.  These amounts may remain available to the participant in years following the employee’s termination of employment.

5. Which Health Costs are Eligible to be Paid For Through an FSA, HRA, and HSA?  Employees can use balances in their FSA, HRA or HSA to pay for any IRS-qualifying medical costs.  IRS-qualifying medical costs can be found in IRS Publication 969 listed on the IRS’s website are www.irs.gov.  These accounts are commonly used to pay for uninsured medical costs such as:  

• Eyeglasses
• Employee deductibles commonly due to hospitals for surgeries and other procedures
• Co-payments due for doctor, dentist, and optometrist visits
• Braces, filings, crowns, cleanings, and other uninsured dental costs
• Laser eye surgery
• Out-of-pocket costs for prescription drugs 

1 If Employee A is not covered by an FSA, in order to be left with $1,000 after-tax to pay the deductible, Employee A would have to receive $1,485 in salary, pay 25% in income taxes and 7.65% in FICA, or $485 in this example, and be left with $1,000 to pay for the braces.  If employee B is covered by an FSA, employee B could set aside the $1,000 pre-tax to pay for the braces and have an extra $485 in his gross income as compared to employee A.  The extra $485 of gross income works out to an extra $370 of net take home pay after income taxes (25%) and FICA (7.65%) are taken out.

2 IRS Notice 2002-45, 2002-28 I.R.B. 93.