The Unlimited Possibilities of the Limited Purpose FSA

In their post (“Managing FSAs to Avoid the Excise Tax”), my colleagues Joe Kra and Alayna Kotlyar broke the bad news that, under the ACA’s excise tax rules, FSA contributions will count in the calculation of “cost” for purposes of determining any tax owed. They also pointed out the value of the limited-purpose (dental/vision only) FSA in a post-2017 world. I’d like to elaborate on that point here.

IRS Notice 2015-16, released in February, offers the possibility that stand-alone dental and vision plans, even if self-funded, may be exempt from the excise tax. Based on this pre-guidance, it stands to reason that a dental/vision-only FSA may also be exempt. Of course, we are all anxiously awaiting more definitive guidance, but assuming that limited-purpose FSAs are exempt, they present several possibilities. (Maybe not “unlimited” possibilities, as the headline suggests, but hey, it made you look!)

Regardless of the type of medical plan offered, when the underlying medical plan plus maximum contributions to a traditional FSA exceed the excise tax thresholds, a dental/vision-only FSA can be a powerful alternative. Dental and vision expenses not reimbursed directly by dental or vision insurance are often a significant way in which FSAs are used today. This value can be preserved.

In addition, a key long-term strategy for many employers to delay or reduce the impact of the excise tax will be to expand the use of high-deductible health plans (HDHPs), which generally have a lower cost than traditional plans. When an employer pairs an HDHP with a dental/vision-only FSA, exempt from the excise tax, they are taking a significant step toward optimizing the value of the benefit program.

Here’s an example of what I mean by “optimizing value.” As the underlying cost of a HDHP approaches the excise tax thresholds, employee contributions to the HSAs may need to convert to an after-tax basis, or be made outside of the employer purview, with a tax deduction taken on the employee’s income tax filing, in order to preserve as much of the tax advantage as possible. At this point the employer can continue to offer a powerful tax-advantaged benefit in the form of a dental/vision FSA. This offering will be particularly valuable to employees looking to maximize their long-term tax-effective savings through an HSA, while at the same time seeking short-term tax-effective funding for things like braces for their children.

The excise tax creates complexities. But employers who are willing to take the time to navigate through these complexities will find ways to add more value to their employees and gain a competitive advantage.

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