Flexible Spending Accounts: Types, Limits, and Eligible Expenses

Flexible Spending Accounts (FSAs) are employer-established benefit plans that allow employees to set aside pre-tax dollars for qualified medical, dental, vision, or dependent care expenses. The Internal Revenue Service governs FSA contribution limits, eligible expense categories, and plan rules under the Internal Revenue Code. FSAs occupy a distinct position within the landscape of pre-tax benefits and tax implications, offering immediate tax relief on contributions but imposing strict use-it-or-lose-it rules that differentiate them from other tax-advantaged accounts.

Definition and scope

A Flexible Spending Account is a salary-reduction arrangement authorized under IRC § 125, which governs cafeteria plans. Employers sponsor FSAs; employees elect a contribution amount during open enrollment, and the elected amount is deducted from payroll in pre-tax installments throughout the plan year. The tax treatment reduces both federal income tax liability and FICA (Social Security and Medicare) payroll tax obligations for the employee, while employers save the employer-side FICA contribution on the amounts employees redirect into FSAs.

FSAs are not portable. If employment ends, access to the account balance ends as well, subject to any COBRA election rights available for health FSAs under the Consolidated Omnibus Budget Reconciliation Act. The IRS distinguishes FSAs sharply from Health Savings Accounts, which are individually owned, portable, and require enrollment in a High-Deductible Health Plan (HDHP).

The IRS publishes annual FSA limit adjustments. For the 2024 plan year, the health FSA contribution limit is $3,200 per employee (IRS Revenue Procedure 2023-34). The dependent care FSA limit is set by statute at $5,000 per household (or $2,500 for married filing separately) under IRC § 129.

How it works

FSA contributions are made through payroll deduction on a pre-tax basis. The mechanics follow a specific sequence:

1. Annual election: During open enrollment, the employee designates a fixed dollar amount to contribute for the plan year. This election is generally irrevocable absent a qualifying life event (marriage, divorce, birth, change in employment status).
2. Payroll deduction: The elected amount is divided across pay periods and deducted before federal income tax and FICA withholding are applied.
3. Account funding: Health FSA funds are available in full on the first day of the plan year — meaning a $3,200 election is accessible on January 1 even though payroll deductions will continue through December. Dependent care FSAs, by contrast, are reimbursed only from accumulated balances.
4. Substantiation and reimbursement: Employees submit claims with documentation (receipts, Explanation of Benefits) or use an FSA debit card. The plan administrator verifies that expenses qualify under IRS guidelines.
5. Forfeiture deadline: Unused balances are forfeited at year-end under the use-it-or-lose-it rule. Employers may offer one of two relief provisions — a 2.5-month grace period extending eligibility into the following year, or a $640 rollover (2024 limit, per IRS Revenue Procedure 2023-34) — but not both simultaneously.

Health FSA vs. Dependent Care FSA — Structural Comparison

A third FSA category, the Limited-Purpose FSA, is available to employees enrolled in an HDHP who also hold an HSA. The Limited-Purpose FSA covers only dental and vision expenses, preserving HSA eligibility without violating the "other coverage" prohibition under IRC § 223(c)(1).

Common scenarios

Scenario 1: Orthodontic expenses. An employee's dependent child requires orthodontic treatment costing $4,800. The employee has elected the maximum $3,200 health FSA contribution. Because orthodontia is an IRS-eligible expense (IRS Publication 502), the employee can use the full FSA balance immediately at the start of the plan year, then pay the remaining $1,600 out-of-pocket or through another dental and vision benefit.

Scenario 2: Dependent care for two children. A married couple with two children in licensed daycare pays $14,000 annually in childcare costs. Their household dependent care FSA cap is $5,000, reducing taxable income by that amount. The remaining $9,000 is paid post-tax but may be partially eligible for the Child and Dependent Care Tax Credit under IRC § 21 — though FSA reimbursements reduce the qualifying expense base for that credit. The intersection of FSA elections and tax credit eligibility is a documented feature of dependent care benefits planning.

Scenario 3: Mid-year employment change. An employee elects $2,400 for the year, spends $1,800 in claims by June, then terminates employment. The remaining $600 is forfeited to the employer unless the employee elects COBRA continuation for the health FSA. COBRA FSA continuation allows the employee to continue spending the remaining balance through the plan year by paying the outstanding premiums — effectively paying back contributions not yet deducted through payroll.

Decision boundaries

The FSA framework intersects with several adjacent benefit structures found across the broader benefits coordination and integration landscape. The boundaries that govern FSA eligibility and optimization are regulatory, not discretionary.

FSA and HSA compatibility: An employee cannot hold a general-purpose health FSA and an HSA simultaneously. The IRS treats an active health FSA as "other coverage" that disqualifies HSA contributions under IRC § 223. The only exception is the Limited-Purpose FSA, which restricts reimbursements to dental and vision. Employees transitioning from an FSA to an HSA-eligible HDHP must ensure no FSA balance carries into the HSA eligibility period, or must shift to a Limited-Purpose FSA.

Grace period vs. rollover: Employers offering a health FSA must choose one relief provision — either the 2.5-month grace period (available through March 15 of the following plan year) or the $640 rollover. Offering both in the same plan year is prohibited under IRS Notice 2013-71 (IRS Notice 2013-71). Employees should confirm which provision their plan offers before the end of the plan year.

Eligible expense determination: The IRS defines eligible medical expenses in IRS Publication 502. The CARES Act of 2020 (Public Law 116-136) permanently expanded FSA-eligible expenses to include over-the-counter medications without a prescription and menstrual care products. Cosmetic procedures, gym memberships, and general wellness items remain ineligible unless specifically prescribed to treat a diagnosed condition.

Dependent care eligibility restrictions: Dependent care FSA reimbursements are limited to care for children under age 13 or dependents who are physically or mentally incapable of self-care. The care provider cannot be a spouse or a dependent claimed on the employee's tax return. These restrictions are codified in IRC § 129(e).

The national reference framework for understanding how FSA options fit within the broader benefit system is accessible through the National Benefits Authority, which maps the full scope of employer-sponsored and government-administered benefit programs across the United States.

References

• IRS Publication 502 — Medical and Dental Expenses
• IRS Revenue Procedure 2023-34 — 2024 FSA Limits
• IRS Notice 2013-71 — Rollover and Grace Period Rules
• Internal Revenue Code § 125 — Cafeteria Plans (via eCFR)
• Internal Revenue Code § 129 — Dependent Care Assistance Programs (Cornell LII)
• [Internal Revenue Code § 223 — Health Savings Accounts (Cornell LII)](https://www.law.cornell.edu/uscode/text/26/223