IRS Chief Counsel issues memo reiterating FSA substantiation requirements


On April 28, 2023, the Internal Revenue Service (IRS) released a Chief Counsel memorandum reiterating the substantiation requirements included in proposed IRS regulations for health flexible spending arrangements (health FSAs) and dependent care flexible spending arrangement (DCFSA). These substantiation rules are longstanding, and there were no changes to the rules in the proposed regulations. However, the memo serves as a reminder to FSA administrators about the importance of proper documentation for expenses claimed through FSAs. Following these rules helps ensure compliance and reduces the risk of audits and penalties.

An important reminder

The Chief Counsel memo reiterates that FSA administrators must have a system in place to substantiate expenses and must deny reimbursement for any expenses that are not properly documented. It also reminds administrators that the reimbursement must be provided within a reasonable period of time after the expense was incurred.

Future scrutiny

As noted by the ECFC, this may also be an indication that plans will be more closely scrutinized during audits. Again, this helps demonstrate why your employers should want to work with a compliant administrator, lest they invalidate their entire plan. Employers found out of compliance could be held responsible for all back payroll taxes and associated penalties, issuance of corrected W2s – which would then require all employees (past and present) to file amended tax returns, likely resulting in additional taxes and penalties. This would represent a major blow to all employees who made what they believed to be valid pre-tax contributions to their FSA or DCFSA.

A competitive advantage

As a benefits administrator, you may have found yourself competing against TPAs who bend the rules, or you may have gotten pushback from employers and brokers for simply following the rules as written. This memo serves to reinforce the importance of operating within the rules – and helps you demonstrate to customers that you’re not imposing undue scrutiny, but simply helping them to remain compliant.

Call to action

We encourage you to take this opportunity to review your substantiation procedures and make any necessary adjustments to ensure the long-term success of your FSA plans and continue providing maximum value to your employee customers.


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