When may an employer take a tax deduction for FSA reimbursements and other benefits?
As a general rule, an employer may not take a tax deduction for flexible spending account (FSA) benefits until the benefits are provided to employees. Thus, no deduction may be taken at the time of the employee’s salary reduction. Moreover, employers who transmit salary reduction amounts to a third-party administrator (TPA) for administration of claims should be careful not to base the timing of deductions on when the amounts are transmitted.
Likewise, the employer may not take a tax deduction when a forfeiture occurs. Rather, deductions will arise when benefits are provided, or amounts are applied against permissible administrative expenses. The timing of an employer’s deduction should not be confused with its accrual of liability from a financial accounting standpoint. For financial accounting purposes, the employer’s liability for health FSA benefits accrues as of the first day of the coverage period (e.g., the plan year), due to the application of the uniform coverage rule. For DCAPs, the liability accrues when the salary reductions occur.
Self-insured medical benefits are governed by similar rules. If not paid from a trust, an accrual-basis taxpayer can deduct them in the year in which the expenses are incurred, even if paid in a later year. In contrast, a cash-basis taxpayer would deduct only when the expenses are paid. Likewise, premiums for insured benefits are deductible when accrued or paid, depending on whether the employer is an accrual-basis or cash-basis taxpayer. The deduction rules for a self-insured health plan that pays benefits from a trust or other “welfare benefit fund” are more complicated and are subject to limitations to prevent excess prefunding.
Certain entities that do not pay corporate taxes, such as governmental employers and nonprofits, can sponsor cafeteria plans without worrying about deductions as such, although these entities may recognize the costs of their plans on a similar accrual or cash basis.
Source: Thomson Reuters