Healthcare FSA 2020 refund

[TaxQuestion2021]

Hello,

I had a healthcare FSA for 2020 and some of it will rollover to 2021 (we were allowed a max of $550 rollover). 

I learned that I am due a partial refund for an expense I claimed in 2020. The refund will be made by a check, the merchant stated they can't refund it to my FSA card directly. 

What can I do with this money? I have learned that there is a "repayment" option to my FSA account. This sounds like it will make things appropriate for tax reasons. The issue is that the repayment will push my 2020 balance above the rollover amount and I will likely lose the excess money.

Is there a proper way around this? This is mostly an issue on the merchant side that they didn't inform me earlier. I could have spent the excess money for something else in 2020.

I saw this post about a similar situation related to an HSA refund. I would be interested in doing something similar to (b) there if that is allowed.

Thanks!

[Opus 17 · Accepted solution]

There is no "repayment" option for an FSA.  There is a "return of mistaken distribution" for an HSA, but that's different.

What you have is called a taxable recovery.  You were reimbursed for something that was tax-free, or a previous deduction.  The reimbursement is taxable income.  It's listed in the "uncommon income" section and it should be called either a taxable recovery or a reimbursement of a previous deduction.  

[TaxQuestion2021]

Thank you very much for your response!

I chatted with my FSA plan administrator and they directed me to this. Seems like they do allow "correcting" transactions. Even if it is allowed, it is not favorable for me though because I will basically lose the excess money that I pay back.

To confirm my understanding, these are my steps for taxable recovery:

- Get the check from the merchant.

- Don't try to correct the transaction / repay etc.

- Claim it as taxable income for my 2020 return.

I like this option better because at least I will get to keep the after-tax money.

[Opus 17]

I should have said there was nothing in the tax code that required a repayment option.  It seems your plan administrator allows one.  If putting the money back would allow you to re-use it for another eligible medical expense within the time limits of your plan, that would be the least-tax option.  But if you can't use it for another medical expense (due to the carry-forward limit or the end of the grace period) then keeping the money and paying the tax on it would make the most sense to me too.  Your steps are correct.