Health FSAs and dependent-care FSAs for employers

There are two accounts employers ask about most often: a health FSA, for eligible medical expenses, and a dependent-care FSA, for eligible work-related dependent-care expenses under Internal Revenue Code § 129. They are separate elections with separate rules and separate caps. Neither one is a medical plan. They sit beside a group policy, an ICHRA, or a QSEHRA, subject to the coordination rules that apply to each arrangement.

What it is

A health FSA reimburses employees for qualified medical expenses as defined in the Code and the plan document — for example, deductibles, copayments, and many dental and vision expenses — up to the amount the employee elected, plus any employer contribution the plan allows. IRS Publication 15-B describes the cafeteria-plan and health-FSA rules that sit around it.

The IRS caps the amount an employee may contribute by salary reduction:

Those figures come from IRS Revenue Procedure 2025-32 and Revenue Procedure 2026-35. A plan does not have to permit carryover. If it does, the carryover cannot exceed the IRS maximum. Some plans instead use a short grace period. A cafeteria plan that does not limit health FSA salary reductions to the dollar limit is not a cafeteria plan, and the benefits become taxable.

A dependent-care FSA is a dependent-care assistance program under IRC § 129. The Code currently caps the exclusion at $5,000 a year, or $2,500 for a married person filing separately. Unlike the health FSA cap, that figure is set in the statute rather than republished each year in the inflation procedure. Your tax advisor should confirm the limit that applies to your plan year. Eligible expenses are work-related dependent-care costs that meet the § 129 tests, as written in the plan.

Who it fits

A health FSA is often a fit when employees will have predictable out-of-pocket medical, dental, or vision expenses during the year and you are prepared to administer elections, substantiation, and a carryover or grace period. A dependent-care FSA is often a fit when employees will have eligible work-related care expenses and you want a pre-tax way for them to pay those costs.

A company that only wants pre-tax premium deductions can stop at a premium-only plan. An HSA-qualified HDHP uses a different account, with different rules, and a general-purpose health FSA is disqualifying coverage for HSA eligibility.

How it works for employers

You adopt a written cafeteria plan that includes the FSA, set eligibility and the election process, and arrange payroll deductions and claims substantiation, usually through a third-party administrator. Elections are irrevocable during the plan year except for the change-in-status events the regulations allow. Uniform availability and the nondiscrimination rules that apply to cafeteria plans matter, especially in a company with a small ownership group. A 2-percent S corporation shareholder is not treated as an employee for § 125 purposes and may not participate in the cafeteria plan; see group health insurance for an LLC.

Health FSA amounts are generally available as of the first day of the plan year, up to the elected amount, which is a cash-flow point to plan for. Dependent-care FSA reimbursements are generally limited to the amount that has been contributed at the time of the claim. Unused amounts are subject to the plan's carryover, grace-period, or forfeiture rules.

How it compares

A health FSA is a year-by-year cafeteria-plan account with a salary-reduction cap and either a limited carryover, a grace period, or forfeiture. An HSA is an account the employee owns, used with an HDHP, with its own annual limit and no year-end forfeiture. An excepted benefit HRA or an ICHRA is funded by the employer, not by employee salary reduction (and a QSEHRA may not be funded by salary reduction at all). Each is a legitimate fit for some groups. We will coordinate the accounts so they do not conflict.