Tax Insider: New Rules for Flexible Spending Accounts

Between deductibles, co-payments, and prescriptions, yearly out-of-pocket costs for the average American who has insurance has increased significantly. In fact, out of pocket costs (not including premiums) rose 30% between 2001 and 2006 according to

Flexible spending arrangements, or flexible spending accounts as they are commonly known, have helped to ease that burden to some extent. When employees put their money into an FSA–also known as a health reimbursement arrangement, health savings account, cafeteria plan, or 125 plan–they reduce their taxable income and can withdraw money specifically to pay for their medical expenses on a pre-tax basis. However, starting Jan. 1, the Affordable Care Act, which was enacted in March, will establish a new standard for such tax-favored arrangements.

For many employees, open enrollment is right around the corner. Here’s what you need to know as you plan to allocate money for your health benefits this fall:

-    Over-the-counter medicines and drugs can no longer be reimbursed from an individual’s FSA, only prescription drugs
-    The change does not affect insulin, even if purchased without a prescription
-    The Act applies only to purchases made on or after Jan. 1, 2011, so claims for medicines or drugs purchased without a prescription in 2010 can still be reimbursed in 2011, but only if allowed by the employer’s plan
-    The new rule does not apply to medical care items that are not medicines or drugs. Thus, equipment such as crutches; supplies such as bandages; items such as eyeglasses, contact lenses; and diagnostic devices such as blood sugar test kits will still qualify for reimbursement by a health FSA or HRA, regardless of whether the items are purchased using a prescription.
-    Co-pays and deductibles continue to be reimbursable from a health FSA after Dec. 31, 2010.  Similarly, funds from an HRA can continue to be used for these expenses, and a distribution from an HSA or Archer Medical Spending Account (designed for the self-employed or small employer) for these purposes will be tax-free.
-    If you purchase items with your HSA or Archer MSA that do not qualify under the new standards, then those medical expenses will be included in your gross income and subject to an additional tax of 20%

Also, keep in mind that healthcare reform legislation, which passed in May, includes provisions that will cap the amount that can be put into FSAs at $2,500 per employee, down from $5000. Thankfully, this change does not take effect until 2013.

For more relevant and timely tax advice visit the Tax Insider.