Ask the Expert: Can We Deduct FSA Balance from Employee’s Last Paycheck?

We have an employee that to date has withdrawn more from their FSA than they have contributed. They have now given their notice to end employment. Can we deduct the balance owed for the FSA off the last check to balance out the amount he has been paid but has not contributed.

Thank you for your inquiry regarding a deduction from pay to cover insufficient funds in a departing employee’s FSA.

Deductions of this type are not permissible under the Section 125 rules for FSAs.
To be a valid Section 125 insurance plan, FSAs must involve “risk-shifting.” This means that both the employee and the plan sponsor (employer) must assume some comparable risk of loss in the plan.

For employees, that risk comes in the form of the “use it or lose it” rules. If an employee contributes $2,500 to an FSA over the course of the year, but does not use those funds by the end of the year, then any excess is forfeited to the plan and this benefits the plan sponsor/employer.

So the plan sponsor/employer must also undertake some risk of loss, and this risk is typically found in early termination scenarios such as that of your inquiry.

The uniform coverage rules for FSAs require that the employee be eligible to receive the maximum amount of reimbursement he or she has elected to contribute for the year at any time during the coverage period, regardless of the amount the employee has actually contributed. So if the same employee noted above elects to contribute $2,500 to the FSA over the course of the year, he or she must be entitled to use of that entire amount at any time during the plan year, even if the employee has only made a single paycheck’s contribution. If the employee leaves employment after that single paycheck, but has spent more than this amount, then the plan sponsor must bear that expense.
If the plan sponsor/employer were permitted to require employees to reimburse any excess expenses, then the plan sponsor/employer would have no risk of loss and the FSA would not be valid.

So the general idea is that employees who participate in your FSA and who do not use the entirety of their contributions by the end of the year balance out any losses sustained by the plan sponsor for early terminations such as that in your inquiry.