An FSA is an employer-sponsored arrangement under the tax-advantaged cafeteria plan rules, created to cover medical expenses as defined under Section 213(d) of the Internal Revenue Code. While contributions to the FSA can be made by the employer or employee, they are typically made by the employee. Employees pay no federal, Social Security or (in most states) state taxes on FSA contributions. There is no IRS limit on annual FSA contributions, but most employers cap contributions at $5,000. FSA funds are subject to a "use it or lose it" provision, and must be used in the year in which they are accrued. Unused funds revert to the employer. Funds are not portable, and do not accrue interest.
Two accounts, the health care FSA and the dependent day care FSA, which allow employees to pay certain health and dependent day care expenses with before-tax dollars.
Many flexible benefit programs include flexible spending accounts, which give employees a choice between taxable cash and nontaxable compensation in the form of payment or reimbursement of eligible, tax-favored welfare benefits. FSAs can be funded through salary reduction, employer contributions or a combination of both. Employees can purchase additional benefits, pay health insurance deductibles and co-payments, or pay for child care benefits with the money in their FSAs.