Flexible Spending Accounts (FSAs) and Dependent Care Assistance Programs (DCAPs) are employer-sponsored benefits that help employees save money on out-of-pocket healthcare and dependent care expenses using pre-tax dollars. Understanding what expenses are allowed and how these accounts function can help you maximize their value while staying compliant with IRS rules.
What Is a Flexible Spending Account (FSA)?
A Healthcare FSA allows employees to set aside pre-tax income to pay for qualified medical expenses. These accounts are governed by IRS §213(d), and while many expenses are eligible, some limitations and documentation rules apply.
FSA Allowed Expenses
Most out-of-pocket medical, dental, and vision expenses are eligible, including:
- Doctor visits and copays
- Dental cleanings and orthodontics
- Eyeglasses and contact lenses
- Prescription medications
Note:
- Premium payments (e.g., health insurance premiums) are not allowed.
- Some over-the-counter (OTC) items and treatments require a prescription or a Letter of Medical Necessity.
- Limited Purpose FSAs—available to individuals with Health Savings Accounts (HSAs)—can only be used for dental and vision expenses.
What Is a Dependent Care Assistance Program (DCAP)?
A DCAP helps employees pay for care of dependents (children or adults) that enables them to work. This account can be used for a range of services related to dependent care.
DCAP Allowed Expenses
Eligible expenses under DCAP include:
- Daycare centers
- Preschool and nursery schools
- Babysitter (in or out of your home)
- Summer day camps (not overnight)
- Before- or after-school care
- Nanny services
- Elder care for dependent adults
To qualify, the care must be necessary for the employee (and spouse, if married) to work or look for work.
Grace Periods and Rollovers: What Happens to Unused Funds?
It’s important to use the funds in your FSA or DCAP wisely, as they are “use-it-or-lose-it” accounts—however, some flexibility is available depending on the employer’s plan design.
Grace Period
- Provides up to 2.5 months after the plan year ends to incur new eligible expenses.
- Applies to both FSA and DCAP (though DCAP can only use the grace period, not rollover).
Rollover
- Allows unused funds to carry over into the next plan year (subject to an IRS-set maximum).
- Available only for Healthcare FSAs, not DCAP.
- A plan can have either a grace period or a rollover, but not both.
Run-Out Period
- A separate period (typically 90 days, set by the employer) to submit claims for expenses incurred during the plan year or grace period.
Documentation Requirements
To ensure IRS compliance and proper reimbursement, documentation is crucial.
FSA Documentation
- Receipts showing the date of service, provider name, and service description.
- Letter of Medical Necessity for certain services or products not typically considered medical.
- Prescription (Rx) for over-the-counter medicines or products like pain relievers, allergy meds, or acne treatments.
DCAP Documentation
- Receipts or invoices with provider details, dates, and amounts.
- Even informal caregivers like babysitters or nannies must provide verifiable documentation.
Final Thoughts
FSAs and DCAPs can significantly reduce your taxable income while covering everyday healthcare and dependent care expenses. But maximizing these benefits requires understanding what’s eligible, how and when to spend your funds, and what documentation to provide.
Be sure to:
- Keep thorough receipts
- Check with your HR team or benefits administrator
- Monitor deadlines for spending and submitting claims
If you’re unsure whether a specific expense qualifies, consult your plan administrator or a tax professional.
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