Compliance Landscape: The More Things Change, the More They Stay the Same

Ferne Emery, Vice President Health & Benefits Compliance Officer, Pinnacle Financial Partners

HR Heroes and clients often ask me, “Can you help us with compliance?” Like any compliance professional, I often reply with a question. “What do you mean by ‘Compliance’ exactly?”

In an ever-changing regulatory landscape, employers can spend days opining on the many rules. For example, as I was writing this, I received a regulatory alert from multiple federal agencies regarding proposed changes to certain employer-sponsored welfare benefits and their tax treatment. I said to myself, “Can you just stop with new rules already? Employee benefit folks need a break!” Despite my silent wish, I do not believe they intend to slow down.

One of the newer alerts to cross my path is not technically new, but it packs a punch. Earlier this year, the Internal Revenue Service released an FAQ regarding Flexible Spending Accounts (FSAs) and other pre-tax reimbursement plans just to tell us, “Nothing has changed.” The alert reiterated existing rules regarding the requirement to “substantiate” FSA expenses to maintain compliant plans.

News flash: They said, “Nothing changed,” but something has changed! They are now enforcing the rules.

What is substantiation?

When explaining substantiation to employers and consumers, I like it to submitting receipts for an employee expense report. To receive a reimbursement from my employer for expenses I incurred while traveling for business reasons, I need to make sure I provide dates, reasons for the expense, detailed receipts showing where and when the expense was incurred, etc. My employer can approve or deny based on our allowed expense list and employee handbook. An expense is either eligible or ineligible, according to the firm’s policies.

The IRS’ expectations for FSA compliance are similar. They require anyone receiving a pre-tax advantage for an FSA expense must then provide documentation to prove it was qualified. Administrators are required to validate the following information on every claim: date(s) of service, amount paid, patient name, provider name, provider location, and services rendered.

Why now?

The Inflation Reduction Act approved by Congress and signed by President Biden in 2022 increased the IRS’s budget by 80 billion dollars. The budget increase provides resources to enforce rules through corporate tax audits.

One possible reason that FSA substantiation is a priority for this effort is that administrators may misunderstand the full IRS requirements and misapply the regulations, and the IRS is aware of this.

Misapplication of the rules includes practices like allowing “de minimis” thresholds before requiring documentation. Some plans violated IRS policies by allowing participants to forgo submitting proof of their expense if they saw certain “preferred” providers. Another misapplication of the rules included employees self-substantiating their own expenses by essentially creating their own receipts without oversight.

“If you sponsor an FSA or another tax advantaged reimbursement plan, your administrator should be validating and substantiating all expenses.”

The IRS doubled down and said, “Again, no.” If you swipe your FSA debit card for 50 cents or 500 dollars, it doesn’t matter who the provider is. You must submit proper documentation provided by an independent third party.

What does this mean for employers and plan sponsors? 

IRS agents are requesting proof of FSA substantiation during corporate tax audits. If you sponsor an FSA or another tax advantaged reimbursement plan, your administrator should be validating and substantiating all expenses. Validating a sample of expenses is not allowed.

At the end of the plan year, employees who did not fully substantiate their expenses should have those amounts included as taxable income on their W-2.

The worst-case scenario for non-compliant FSAs, and other tax-advantaged plans is plan disqualification. This results in employer taxes and penalties on all paid claims, not just the ineligible ones.

That’s a huge deal.

Technology and education can help! 

There are legal methods available to streamline the substantiation process by approving certain expenses automatically.

Examples of these auto-substantiation methods include:

1. Automatically approving insurance copayment amounts. Copayment amounts can be set to be approved automatically if the card is swiped at a doctor’s office. Employers must provide administrators with insurance copayment details to implement this.
2. Encourage employees to make over-the-counter purchases and have prescriptions filled at stores and pharmacies that participate in the Inventory Information Approval System (IIAS) network. FSA debit cards used at these locations may be approved at the point of sale for qualified expenses.
3. Connect a claim feed between your insurance carrier and FSA administrator. After opt-in by the participant, claim information can be sent to the FSA administrator via a secure file from your carrier. This feed substantiates many health insurance expenses automatically when amounts and payees match up.

Many administrators also offer mobile applications that use a smartphone camera to scan barcodes for qualified expenses and capture receipts and explanations of benefits to submit when any documentation is required.

What next? 

Employers and plan sponsors may be surprised to find that they are the parties responsible for compliance. Employers should seek their own legal and tax advice, as well as verify that administrators are equipped to help operate compliant plans. This includes substantiating all expenses, assisting with the preparation of any legal plan documents, providing automated claim reports (including denied claims), and performing annual nondiscrimination testing. Employers should educate employees on the importance of requesting documentation from their providers and insurance carriers.

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