Managing FSAs to Avoid the Excise Tax
The ACA’s 40% excise tax will apply to “high cost employer-sponsored health coverage” as of 2018. “High cost” is defined as $10,200 for single coverage and $27,500 for family coverage. That seems fairly straightforward — until you take into account that the tax is calculated based on the “aggregate cost” of applicable employer-sponsored coverage over the threshold, not just medical premiums.
Health account funding is one of the components that must be considered when determining exposure to the excise tax. This includes:
- Health Flexible Spending Accounts (FSAs).
- Health Reimbursement Accounts (HRAs).
- Employer contributions to a Health Savings Account (HSA).
- Employee pre-tax contributions to an HSA.
Dependent care FSAs and employee funding to an HSA outside of an employer’s health plan are not considered when projecting exposure to the excise tax.
We expect that the exposure may be measured at an employee level. For example, if the cost of single coverage for a medical plan is $9,000 and an employee elects to contribute $2,000 to a health FSA, then the aggregate cost for that employee would be $11,000 ($9,000 plus $2,000). The excise tax for that employee would be $320 ($11,000 minus $10,200, multiplied by 40%). This calculation does not consider the average FSA contribution for other employees may be lower than $2,000.
The following table outlines several strategies to mitigate an employer’s excise tax exposure from a health FSA:
| Mitigation Strategy | Description | Benefits/Drawbacks |
| Limit FSA contributions. | The maximum FSA contribution limit is $2,550 for 2015 and is indexed annually. An employer can reduce the maximum allowed based on the gap between the excise tax thresholds and the employer’s highest-cost medical plan. | Benefit: Employees can continue to contribute to traditional FSA. Drawbacks: Maximum funding is decreased and the employer will need to revisit the maximum annually. |
| Vary FSA account funding by medical plan option. | Similar to the above, but allow additional FSA funding for plans with lower medical plan costs. | Benefit: Allows additional FSA funding for enrollees in lower cost plans; can help encourage migration to less costly plans. Drawback: Cumbersome to administer. |
| Change FSA so it doesn’t count against excise tax threshold. | Implement a limited purpose FSA that can only be used for dental and vision. | Benefit: Allows maximum funding to FSA. FSA funds are often accessed for dental and vision expenses. Drawback: FSA cannot be used for medical expenses. |
| Eliminate the FSA. | Removal of the account. | Benefit: Employees may have opportunity to fund an HSA if enrolled in a qualified HDHP. Drawback: Employees lose access to a valued tax benefit |
If you offer an FSA, you should consider possible changes prior to open enrollment for the 2017 plan year. An employee may adjust their FSA election in 2017 if he or she is aware the FSA will change in 2018. For example, if an employer allows funds to roll over to the next year but won’t allow new funding in 2018, an employee may elect a higher FSA amount for 2017 to help cover expenses in 2018. On the other hand, if an employer plans to offer an HSA-qualified plan in 2018, an employee may choose to contribute less in 2017 so that their balance is depleted prior to the end of the year. If an employer allows an FSA roll-over, remaining FSA funds can disqualify an employee from opening an HSA as of January in the following year.
While we are still waiting for regulatory guidance that may influence the considerations and options described above, it’s not too early to start planning.