Generally, yes, but not necessarily.
One of the most common questions employers ask when setting up a Flexible Spending Account (FSA) is whether they must offer the benefit to every employee. The answer depends on how the plan is designed and which employees are eligible under the plan document.
While employers have flexibility in establishing eligibility requirements, they cannot simply choose which individual employees may participate.
How FSA Eligibility Works
A Healthcare Flexible Spending Account (FSA) is offered through a Section 125 Cafeteria Plan.
When an employer adopts a Cafeteria Plan, the plan document establishes who is eligible to participate.
Employers generally create eligibility rules based on objective classifications, such as:
- Full-time employees
- Employees who have completed a waiting period
- Employees working a minimum number of hours
- Employees in a particular employment classification
These rules should be applied consistently.
Can I Exclude Certain Employees?
Yes.
Federal rules allow employers to exclude certain categories of employees if the plan is properly designed.
Common exclusions may include:
- Employees who have not satisfied the waiting period
- Part-time employees
- Seasonal employees
- Temporary employees
- Employees covered by a collective bargaining agreement (in certain circumstances)
- Nonresident aliens with no U.S. source earned income
Your plan documents should clearly define who is eligible.
Can I Offer an FSA Only to My Managers?
Generally, no.
Employers cannot simply decide to offer an FSA only to executives, managers, or other favored employees.
Section 125 Cafeteria Plans are subject to nondiscrimination rules that are designed to prevent benefits from disproportionately favoring highly compensated employees or key employees.
If a plan fails applicable nondiscrimination testing, the plan itself generally does not become invalid. Instead, certain tax advantages may be lost for the highly compensated or key employees who benefited from the discriminatory plan design.
For that reason, employers should avoid designing an FSA that intentionally favors one group of employees without understanding the applicable rules.
What If I Only Have One Employee?
A business with only one common-law employee may still be able to establish an FSA, depending on the circumstances.
However, owner eligibility is a separate issue.
For example:
- Sole proprietors generally cannot participate.
- Partners in a partnership generally cannot participate.
- More-than-2% shareholders of an S corporation generally cannot participate in a Section 125 Cafeteria Plan on a tax-favored basis.
Even if the owners are not eligible, eligible employees often are.
Can Different Employee Groups Have Different Eligibility Rules?
Sometimes.
Employers may establish reasonable eligibility requirements, provided they comply with applicable tax rules and are reflected in the plan documents.
For example, a plan might require:
- 30 days of employment
- 60 days of employment
- 90 days of employment
before employees become eligible.
The important point is that the rules should be objective and consistently applied.
Do All Eligible Employees Have to Participate?
No.
Once an employee becomes eligible, participation is generally voluntary.
Some employees choose to enroll because they expect significant medical expenses.
Others may decide not to participate during a particular plan year.
The employer’s responsibility is to make the benefit available to eligible employees—it is up to each employee whether to enroll.
Why Do Employers Limit Eligibility?
There are several reasons employers establish eligibility requirements.
For example:
- To avoid enrolling very short-term employees.
- To align FSA eligibility with other employee benefits.
- To simplify administration.
- To provide benefits primarily to regular employees.
Thoughtfully designed eligibility rules can help balance employee access with administrative efficiency.
How Empower Helps Employers Design FSA Eligibility
When implementing an FSA, Empower helps employers:
- Establish appropriate eligibility requirements.
- Prepare required Section 125 plan documents.
- Communicate eligibility rules to employees.
- Administer enrollments.
- Answer employer and employee questions.
Our team works with employers to create an FSA that complies with applicable requirements while meeting the organization’s benefit goals.
Questions About FSA Eligibility?
Every employer’s workforce is different, and the right eligibility rules depend on your organization and your objectives.
If you’re considering implementing an FSA—or reviewing an existing plan—Empower can help you understand your options and establish an eligibility structure that works for your business.
Contact Empower to learn more about offering a Flexible Spending Account to your employees.
