Tactical steps to ensure Lifestyle Spending Account eligible expenses are compliant
Know what to do (and not to do) to ensure lifestyle spending account eligible expenses are compliant and useful.
Supporting employees with lifestyle spending accounts
Lifestyle spending accounts (LSAs) have great appeal to companies and employees alike, and with good reason. LSAs, which are essentially employer-funded accounts that employees can use to support their needs and goals, offer a level of choice and flexibility that is almost unparalleled. While LSAs aren’t exactly new, their popularity has accelerated in recent years as companies compete for talent and employees have more leverage to demand the benefits they want.
In a recent survey by Mercer, 70 percent of employers said they are considering adding an LSA to their benefits package. This popularity is due to a variety of factors, including:
- LSAs enable companies to augment employee compensation without making a permanent commitment such as a salary increase.
- LSAs alleviate point-solution overload while providing a variety of services, products, or experiences to fit each employee’s unique lifestyle.
- LSAs are easy to scale and can support a dispersed and global workforce.
With all these advantages, LSAs rightfully occupy a desirable position in the world of employee benefits. Yet, with significant investment and market position at risk, companies should follow a few simple steps to take to ensure their LSA program is compliant and successful.
3 steps to ensure lifestyle spending account eligible expense compliance
A major reason LSAs are appealing to both employers and employees is their flexibility. Employers can select set parameters for eligible expenses that factor a wide range of individual employee needs. Below are 5 steps to consider for eligible LSA expenses and ensure the program is compliant.
1. Treat eligible LSA expenses as taxable income.
Compliance for LSAs is relatively simple compared to tax-advantaged accounts such as health savings accounts (HSAs), flexible spending arrangements (FSAs), and health reimbursement arrangements (HRAs). This makes LSAs refreshingly easy to administer.
However, LSA benefits are not excluded from income and, therefore, are always treated as taxable to employees. Generally, employers handle this by including the amount of each LSA reimbursement in the employee’s gross income and, thus, applying withholding and payroll taxes to these amounts. Any LSA funds made available to employees but not reimbursed (i.e., carried over or forfeited) are not included in the employee’s taxable income. It's best to work with a trusted consultant to offer sound guidance to ensure compliance.
2. Take advantage of the flexibility LSAs provide.
Employees can use funds to cover the cost of expenses incurred in life. It’s up to the employer to decide what expenses are or are not covered. Eligible LSA expenses can be unrestricted and constructed as a means to support a wide range of employee needs, unique and relevant to individuals on a global scale. The list of categories covered is long, ranging from health and wellness programs to family needs and personal development or growth.
Some examples of eligible expenses include:
- Gym memberships
- Wellness apps
- Home office supplies
- Wifi or mobile
- Professional development classes
- Pet care
- And more!
An added bonus of LSAs is that they're not tied to open enrollment. Companies can implement these plans and unlock their potential anytime. Even better, modern LSA systems like Forma provide the opportunity to adjust the program at any time - which can be a powerful tool for companies and workforces large and small.
3. Be mindful of tax-advantaged medical and health expenses.
One of the most exciting parts of an LSA program is that it can accommodate almost any type of expense. However, there are a few important caveats. Wellness accounts are among the most popular LSAs and can fund a vast array of expenses that improve employee health and wellness. In fact, about a third of Forma’s customers offered a wellness account to their employees in 2022.
Since LSA funds are taxable income for employees, be sure not to include expenses that can be more impactful with a tax-advantaged account. Various programs, such as dependent care FSAs, educational assistance programs, commuter benefits, and adoption expenses can all be provided on a tax-advantaged basis outside the LSA.
Furthermore, employers should be careful to restrict and monitor any expenses considered medical expenses, such as smoking cessation programs, chiropractic treatment, and acupuncture. LSAs cannot cover any such medical expenses because they would trigger group health plan regulatory requirements and laws (ERISA, COBRA, HIPAA, ACA, HSA eligibility, etc.). Employers can use health FSAs, HRAs, and HSAs for medical expense purposes. The IRS has a useful summary of what qualifies as a medical expense here.
As noted in step 1, it's best to work with a trusted advisor to ensure adherence to IRS guidelines and compliance. Working with an experienced team that's familiar with IRS compliance guidelines (like Forma) can be a game changer when building - and launching an LSA program successfully. In fact, Forma has provided such guidance and helped customers roll out adoption, commuter, student loan, and work-from-home programs successfully.
Eligible expenses: Some expenses, such as gym membership, massage, and nutritionist fees, are known as “dual purpose expenses.” These expenses would mostly be considered non-medical. Still, they could qualify as medical expenses if they are incurred as a result of advice from a medical practitioner to treat a specified medical condition. Employers can include dual-purpose expenses in the LSA as long as employees don’t need to qualify based on their medical status.
Support individual employee needs with LSA programs
LSAs are one of the most attractive employee benefits options for both companies and employees. Because LSA benefits are provided post-tax, these accounts are subject to very few restrictions. That flexibility gives them the ability to be a truly customizable benefit that can meet each employee where they are. In addition, they are easy to scale and can satisfy the needs of a global workforce.
However, when building an LSA program, it is important to remember these key points:
- LSAs are not tax-advantaged accounts and therefore will be included in employees’ taxable income.
- To maximize tax efficiency, avoid including expenses in an LSA that can be part of a tax-advantaged account.
- Medical expenses should never be included in an LSA to avoid group health plan status and associated laws.
Forma’s comprehensive LSA platform can help ensure a program is both compliant and successful. By leveraging Forma’s expansive experience designing and implementing LSA programs, companies can avoid regulatory pitfalls and maximize benefits investments. Forma’s “universe of benefits” makes it easy for HR leaders and administrators to select the variety of options most appropriate for their employees. And employees can “shop” for the benefits that work best for them through Forma’s vendor marketplace.
Schedule a consultation with Forma today to ensure that your LSA program is compliant, successful, and durable.