September 19 Tip of the Week

“FSAs and Unpaid Leaves of Absence”

            Flexible spending accounts are a great way for employees to put aside money for both health care and dependent care expenses incurred throughout the year.  Employers have a love/hate relationship with these plans because, while they provide a great employee-funded pretax benefit, employers can be left holding the bag if an employee uses their allotted yearly contribution before they fully fund it and the employee leaves their job at any time during the year.  Flexible spending accounts are a benefit that most employees have come to expect as part of their overall compensation package and are generally easy to maintain and low cost to the employer.  Questions arise, however, as to what happens when an employee is on an unpaid leave of absence. 

            At first glance, the answer seems obvious – if the employee is not receiving any pay and cannot make their contribution to the FSA plan, then they shouldn’t be allowed to continue to participate in the FSA.  If they are allowed to continue in the FSA, then the employer will be required (in most instances) to pay out more in benefits than the employee makes in contributions.  As is often the case, the easy answer is not always the right answer. 

The Internal Revenue Service, the government agency that sets the rules for this type of tax-deferred benefit, has established a different rule with respect to FSA participation.  Consistent with the requirements of the Family and Medical Leave Act, the law that governs the majority of unpaid leaves of absence, an employee is allowed to continue to participate in the FSA during their leave.  By continuing to participate, however, the employee must continue to make those tax-deferred contribution to the plan.  Under IRS rules, employees have four options regarding their participation in an FSA when they go out on an unpaid leave of absence:  (1) the employee can end their participation in the FSA (the unpaid leave acts as a qualifying event to change the employee’s coverage option); (2) the employee can pre-pay their contributions to the FSA through wage deductions in advance of their leave; (3) the employee can pay their FSA contribution to the employer while on leave; or (4) the employee can repay or catch up on their unpaid FSA contributions through wage deductions upon their return from leave. 

            These options make sense when an employee is out of work due to a medical condition – either their own or a family member’s.  Continued participation in the FSA will allow the employee to pay some of the costs incurred as a result of the medical care received for their or their family member’s health issue on a pre-tax basis, thereby reducing the medical costs they incur.  This does not apply, however, with respect to the other type of benefit available under an FSA – dependent care benefits.  The IRS has established a rule that an employee is allowed to receive dependent care benefits from an FSA only if the employee is actively at work or seeking work.  There is a safe harbor provision in the IRS rules that says an employee can continue to receive dependent care benefits from their FSA for absences of up to two weeks (such as short-term temporary illnesses or vacations), beyond that the employee cannot receive dependent care benefits from their FSA.  This means that the employee who goes out on a maternity leave and then stays home to care for their child cannot continue to receive dependent care benefits from their flexible spending account. 

            What does this mean for employers?  First, employers should review their flexible spending account plan documents to make sure that these rules are accurately depicted in those documents.  Second, employers should make the limitations on FSA benefits clear to employees when an employee is planning an unpaid leave of absence.  Finally, employers should ensure that they are offering employees the ability to make a decision regarding their continued participation in the FSA while on an unpaid leave and, should the employee choose to continue their participation in the plan, make it clear how each of the payment options work.  At myHRcounsel, we can assist you in ensuring that you are in compliance with these and other employment laws.