Why debit card substantiation for HRAs and FSAs matters

Not vetting third party administrators could be putting your clients at risk. Why? If a flexible spending account or health reimbursement account is not administered correctly and in compliance with regulations, plan sponsors are at risk of losing the plan’s tax qualified status.

It’s time to audit your TPAs substantiation process. While the IRS has issued guidance, FAQ’s, information letters and the like on substantiation requirements, some TPAs simply ignore or deem them insignificant.

If you are giving your clients TPA referrals, you need to do your due diligence. If not, you could be potentially putting them at risk. You also could lose your client if you refer them to an unvetted TPA.

It is your responsibility to be knowledgeable of your client’s compliance with IRS Section 125 regarding cafeteria plans. The sponsor has the legal obligation to ensure their plan is compliant. If a cafeteria plan fails to comply with Section 125, “the plan is not a cafeteria plan and employee’s elections between taxable and non-taxable result in gross income to the employees,” according to Prop. Treas. Reg. 1.125-1(c)(7).

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Every debit card transaction must be substantiated. For example, IRS letter 2016-0013 to a FSA participant who questioned whether a TPA could ask for certain information from his doctor before reimbursing his claim for supplements. The IRS explains that FSAs can only reimburse medical expenses substantiated by the employee. Reimbursement of ineligible expenses puts the FSAs nontaxable status at risk, the IRS says.

Because in this case the TPAs request for information was reasonable, the IRS letter says that if the administrator determines that documents from a physician’s office are inadequate, the employee must submit additional documentation for reimbursement.

A TPA who’s claims process does not require substantiation on claims below a certain dollar threshold, whether $5 or $300, is not meeting IRS requirements and is putting the nontaxable status of the sponsor’s plan at risk.

Plan sponsors should not put their FSA or HRA in jeopardy. It is true that substantiation can be difficult for employees to navigate. But, if claims are not validated, employees pre-tax contributions to their FSAs could suddenly become taxable income.

You also want to avoid a client’s FSA or HRA reimbursement being included in employee income. This could result in employee relations issues, amended quarterly tax returns and associated late filing penalties.

So what can advisers do? The first step is to review the below and familiarize yourself with the process.

· Prop. Treas. Reg. 1.125-1 Cafeteria plans, general rules;
· Prop. Treas. Reg. 1.125-6 Substantiation of expenses for all cafeteria plans;
· Office of Chief Counsel Internal Revenue Service memorandum Number 2016-0013;
· IRS Publication 502, Medical and Dental Expenses.

Once you are fully knowledgeable on the substantiation process, you will be ready to assist your clients with TPA vetting prior to signing any contract.