Ensuring the proper administration of a Health Flexible Spending Account (FSA) is crucial to compliance with IRS regulations. In this blog, we delve into the corrective measures employers and their third-party administrators (TPAs) can take when improper payments occur in the Health FSA. Understanding the steps outlined by the IRS is essential to rectifying errors and maintaining compliance.

Correcting Improper Health FSA Payments: A Step-by-Step Guide

Overview of Improper Payments:

Health FSAs are designed to reimburse qualified medical expenses, as defined by §213(d). However, situations arise where employees receive ineligible distributions, such as processing errors or reimbursement of non-qualifying expenses.

IRS-Approved Steps for Correction:

The IRS provides a comprehensive guide for employers and TPAs to address improper Health FSA payments.

Step 1: Deactivate Debit Card if Used:

If a Health FSA debit card was involved in the improper payment, the employer must deactivate it until the erroneous payment is recovered. Claims should then be submitted using standard methods.

Step 2: Three Steps in Any Consistent Order:

  • Employer Demands Repayment: Employers notify employees to repay the improper distribution, making the amount available for future claims.
  • Employer Withholds Amount (Generally Not Recommended): Withholding the improper charge from an employee’s pay is subject to state wage withholding laws and is often not recommended.
  • Offsetting Reduction to Subsequent FSA Claim: Applying a claims substitution or offset allows the plan to reduce subsequent valid claims by the amount of the improper payment.

Step 3: Include Improper Payment in Taxable Income:

This step is the last resort and involves treating the improper payment as business indebtedness. The employer reports the amount in the employee’s taxable income on Form W-2.

Addressing Improper Payments in Subsequent Plan Years:

If the above steps are not completed during the plan year of the improper payment, Step 3 is applied in the subsequent year, and the amount is included in the employee’s taxable income.

TPA Involvement:

While TPAs often handle day-to-day operations, the employer remains responsible. The IRS acknowledges that TPAs can apply correction procedures on behalf of the employer, emphasizing the employer’s fiduciary duty in selecting and monitoring TPAs.


Mistakes in administering Health FSAs are common, but the IRS-approved correction process provides a structured approach. Employers and TPAs should be vigilant in minimizing errors and follow the outlined steps for correction.


This analysis serves as general information and not legal advice. Specific issues should be addressed with individuals providing legal advice on employee benefits matters.

Please enable JavaScript in your browser to complete this form.

Similar Posts