You recently switched to a new third-party administrator (TPA) for your health Flexible Spending Account (FSA). The new TPA deactivated one employee’s FSA debit card because of $20 in expenses that weren’t properly documented. They said this action is required by the Internal Revenue Service (IRS). Your previous TPA told you that expenses under $25 didn’t need documentation and that they would never deactivate a card for unsubstantiated charges. So, who’s right?
The short answer
According to IRS guidance¹, your new TPA is generally following the rules. The IRS requires that all FSA expenses, regardless of amount, be properly documented. Some purchases can be automatically verified at the time of payment, but others typically need additional proof afterward. If your employee doesn’t provide this proof, IRS guidance outlines specific steps you should follow—starting with deactivating their debit card.
Why does this matter to you?
If FSA claims aren’t properly documented, the IRS could disallow your entire cafeteria plan’s tax benefits. That means your employees might owe taxes on benefits they thought were pre-tax, including medical, dental, and vision coverage. This could also lead to penalties and additional taxes for both your company and your employees.
How FSA debit card substantiation works
1. Automatic verification
Many FSA debit card purchases are automatically verified at the time of payment. This happens when the merchant uses an inventory approval system or when the expense matches a known co-pay or recurring claim. These purchases generally don’t require extra paperwork.¹
2. Additional documentation needed
Some expenses—like certain dental or chiropractic visits—cannot be automatically verified. After the purchase, your employee should provide receipts or invoices to prove the expense was eligible. If they don’t, IRS guidance requires you to follow certain steps to recover the amount.²
What you should do when expenses aren’t documented
If your employee doesn’t provide proof for a debit card charge, IRS Revenue Ruling 2003-43 and related regulations generally require you to:
- Deactivate the employee’s FSA debit card until the amount is repaid or resolved.²
- Request repayment from the employee for the unsubstantiated amount.²
- Withhold repayment from the employee’s wages, if allowed by your state laws.³
- Offset the amount against future substantiated claims during the same plan year.²
- Treat any remaining unpaid amount as a business debt, following your company’s usual practices.²
Deactivating the card is typically the first required step. Skipping this step could put your plan’s tax benefits at risk.
Important details to keep in mind
- There is no minimum amount for documentation. Even expenses under $1 generally must be substantiated.²
- Your TPA might say they “never deactivate cards,” but often that means they only do so if you ask them. Make sure you understand your TPA’s policies and IRS requirements.
- If you withhold wages to recover unsubstantiated amounts, check your state laws first to ensure compliance.³
- Forgiving unsubstantiated amounts too often may lead the IRS to question whether your plan is following proper procedures, which could jeopardize your tax benefits.² ⁶
What you should do next
- Review your TPA’s policies on FSA debit card substantiation and card deactivation.
- Communicate clearly with your employees about the importance of keeping receipts and submitting documentation promptly.
- Follow the IRS-required steps if an employee doesn’t provide proof for a debit card charge.
- Consult your legal or tax advisor if you have questions about withholding wages or handling uncollected amounts.
Why this matters
FSA debit cards can be a helpful benefit, but they don’t remove the need for documentation. Following IRS rules helps protect your company’s tax advantages and helps your employees avoid unexpected tax bills. If your TPA suggests otherwise, it’s important to ask questions and ensure your plan stays compliant.⁵ ⁶
References
¹IRS Notice 2006-69 describes IIAS substantiation and clarifies other methods of automatic substantiation.
²Proposed Treasury Regulation §1.125-6(d)(7). These regulations were proposed in 2007 but specifically provide that employers and other taxpayers may rely on the proposed regulations until final regulations are issued.
³With respect to an FSA, which is a form of self-insured group health plan, any state law prohibiting withholding from wages may be preempted by ERISA. See: DOL Advisory Opinion 2008-02A, DOL Advisory Opinion 96-01A, and DOL Advisory Opinion 94-27A.
⁴Proposed Treasury Regulation §1.125-6(d)(1).
⁵Proposed Treasury Regulation §1.125-6(b)(3).
⁶Proposed Treasury Regulation §1.125-1(c)(7)(ii)(G).
