Rising healthcare costs have helped spark expansion in consumer-directed healthcare (CDH). In response, many people are more actively managing their healthcare expenses with the help of CDH resources such as Flexible Spending Accounts (FSA) and Limited Purpose Flexible Spending Accounts (LPFSA).
These accounts reduce your tax burden on out-of-pocket healthcare expenses after insurance has paid its share. Let’s look at the two types of healthcare FSAs.
Flexible Spending Accounts
A full FSA is a benefits account to which you contribute pre-tax funds (money deducted from your paycheck before payroll taxes are calculated). It’s a popular option in many employer-sponsored benefits packages. FSA funds can be used for a long list of qualified healthcare services and products. To use the account efficiently, you need to know which expenses are eligible.
The IRS determines which expenses are qualified for FSA accounts, and the list doesn’t change very often. However, in 2020, as part of the COVID-19 pandemic response, the IRS again qualified over-the-counter (OTC) drugs and medications, which were removed from the list in 2011 as part of the Affordable Care Act legislation. Menstrual care products were also added as eligible products for the first time. Then, in March 2021, COVID-19-related Personal Protective Equipment (PPE) was added to the list.
Below is a list of everyday healthcare expenses and their eligibility status for full FSA accounts.
- Alcoholism and Drug Addiction treatment
- Ambulance services
- Annual physical examination
- Body scan (electronic)
- Dental treatments (most)
- Disabled dependent expenses for medical care
- Eye exams
- Eye surgery
- Fertility treatments
- Home for the Intellectually and Developmentally Disabled
- Hospital services (including meals and lodging)
- Laboratory fees (associated with medical care)
- Lead-based paint removal
- Long-term care and services for chronically ill individual
- Nursing home and services
- Organ transplants
- Psychiatric care
- Smoking cessation programs
- Special education
- Transportation expenses for medical treatments and services
- Weight loss program (requires medical letter of necessity)
- Artificial teeth
- Birth control and contraceptive devices
- Braille reading material
- Breast feeding supplies/lactation expenses
- Capital expenses (home improvements that accommodate a disabled person)
- Communication equipment for the deaf or speech impaired
- Contact lenses and eyeglasses
- Co-pays, co-insurance, and deductibles
- COVID-19 PPE (Hand sanitizers, wipes, and masks for personal use)
- Crutches (purchased or rented)
- Diagnostic devices (blood sugar monitors, blood pressure monitors, etc.)
- Guide dog or other service animals
- Hearing aid expenses (batteries, repairs, and maintenance)
- Insulin and diabetic supplies
- Medical Conference expenses (if related to personal chronic illness)
- Menstrual care products
- Over-the-counter (OTC) medications
- Oxygen and oxygen equipment
- Pregnancy test kits
- Prescription drugs and medicine
- Prosthesis (including artificial limbs and breast reconstruction surgery)
- Smoking cessation aids (OTC medicines such as nicotine gum and patches)
- Wigs used to conceal hair loss from a disease or medical treatment
- Vehicular expenses (for operational and design costs that accommodate a disabled person)
Common Healthcare Expenses that are NOT FSA-Eligible
- Babysitting, childcare or nursing for healthy baby
- Controlled substances that are illegal under federal law, like marijuana, laetrile, etc.
- Cosmetic surgery that does not fix/treat deformity or illness like a facelift, liposuction, etc.
- Dancing lessons
- Diaper services that do not manage the effects of a disease
- Funeral expenses
- Future medical care
- Hair transplant or removal
- Health club dues
- Household help
- Illegal operations and treatments
- Insurance premiums
- Maternity clothes
- Medicines and pharmaceuticals from another country
- Nutritional supplements
- Swimming lessons
- Teeth whitening
- Veterinary fees for animals not qualified as service or support
FSA-Eligible Expenses Require IRS Approval
The IRS decides which products and services are eligible for purchase or payment using FSA funds. Guidance is available in IRS Publication 502, Medical and Dental Expenses:
Medical expenses are the costs of diagnosis, cure, mitigation, treatment, or prevention of disease and the costs for treatments affecting any part or function of the body. These expenses include payments for medical services considered legal in the U.S. rendered by physicians, surgeons, dentists, and other medical practitioners. They include the costs of equipment, supplies, and diagnostic devices needed for these purposes.
Medical care expenses must be primarily to alleviate or prevent a physical or mental defect or illness. They don’t include expenses that are merely beneficial to general health, such as vitamins, supplements, or a vacation.
FSA-eligible products can be found in pharmacies, grocery stores, and department stores such as Walmart and Target. Often, they are marked with special signage. You can also visit online specialty retailers such as FSAStore.com* for convenient purchase and delivery options.
Some Important Notes About FSA Usage
- Many FSA plans come with debit cards for easy shopping. Often you will not have to submit purchase receipts for debit card transactions.
- Always keep the receipts for your purchases. You may be required to submit purchase documentation even if the debit card was used, and you will need receipts to verify healthcare expenses if the IRS should audit you.
- Your FSA account funds can be used on expenses for you and your tax dependents. Tax dependents do not have to be legally related, within a certain age range, or covered by your insurance policy. They just have to be tax dependents as defined by IRS rules.
- Thanks to what is known as the Uniform Coverage Rule, you have access to the full amount of your annual FSA contribution from the first day of the plan year, even though you are paying the contribution into your account in equal installments throughout the year. For example, if you elect an annual contribution of $2,500 and have a qualified $2,500 expense on the first day of the plan year, you can use your entire FSA to pay that expense. Then you will pay the account back over the course of the plan year as you make contributions out of each paycheck.
Limited Purpose FSA
A Limited Purpose FSA is just like a full FSA but can only be used for eligible vision and dental expenses. However, unlike the full FSA, an LPFSA can be held at the same time as a Health Savings Account (HSA). When coordinated with an HSA, the LPFSA can further reduce your taxes while allowing you to allocate HSA funds to other purposes – including retirement.
Plus, you can set aside money in the Limited Purpose FSA specifically for dental and vision expenses. By eliminating the need to use your HSA funds for these expenses, you have more to spend on other healthcare expenses. More important, funding dental and vision expenses from an LPFSA may also allow you to keep more savings in your HSA. Over time, those additional savings can help your retirement nest egg grow larger.
Who Is Eligible?
To establish an LPFSA, you must be enrolled in both an HSA-qualified health plan and an HSA. Under current IRS rules, you cannot deposit money into an HSA if you participate in a full FSA. However, because an LPFSA restricts reimbursements to dental and vision care expenses, the IRS allows you to participate in both an LPFSA and an HSA at the same time. By having both accounts, you can maximize your tax and savings benefits.
How It Works
A Limited Purpose FSA works just like a full FSA, except for the limited number of eligible expenses. You designate a certain amount of money to be taken out of each paycheck and deposited into your LPFSA account. You then use these pre-tax dollars to pay for eligible vision or dental expenses. Qualified expenses include eye exams, eyeglasses, contacts, regular dental checkups, fillings, crowns, and braces, among others. (Check with your plan administrator for a full listing of eligible expenses.)
As with an FSA, your spouse and dependents are also covered under the plan. In addition, depending on how your LPFSA is structured, you may be able to carry over unused money into the next year.
Also, like a full FSA, annual contributions to an LPFSA cannot exceed amounts set by the IRS. It pays to keep close tabs on your account balance at all times. With some administrators, any claims submitted after you exhaust your LPFSA funds during a plan year are automatically reimbursed from your HSA. Check with your administrator to confirm how excess LPFSA claims are handled under your plan.
No “Double-Dipping” Allowed
It’s important to understand that you cannot use funds from both your limited purpose FSA and HSA to cover the same eligible expense, even if the expense is considered eligible under both plans. That’s called double-dipping. Instead, you must decide which account will reimburse your expense.
Also, because LPFSA funds are pre-tax, you can’t deduct the reimbursed expenses again on your annual tax return. To avoid mistakes, keep in mind that the IRS counts eligible expenses from the day you received the service, not the day you were billed or paid for it. For example, if you had a tooth filled on December 28, 2021 but didn’t pay for it until January 2022, the expense would count for 2021.
A Limited Purpose FSA offers a tax-friendly tool for paying dental and vision expenses while potentially adding to your HSA savings. If your employer offers this type of plan, signing up for it can enhance your current cash flow while contributing to your long-term financial security.
To learn more about FSAs and Limited Purpose FSAs, please contact your third-party administrator or HR department.
DataPath Summit is a cloud-based administration platform for FSAs, Limited Purpose FSAs, HSAs, HRAs, and Transit/Commuter accounts. Summit is an ‘everything you could need solution’ with streamlined financial processes including debit cards and electronic payments.