As of 2015, there are no taxable items under a flexible spending arrangement, or FSA, as long as the items are eligible medical expenses, explains Aetna. Sales tax or hospital surcharges, even on over-the-counter medications, are considered legitimate medical expenses.
Because of Affordable Care Act regulations, as of Jan. 1, 2011, over-the-counter medications are not acceptable FSA expenses unless prescribed by a doctor, according to Aetna. There are also no income tax reporting requirements for FSA contributions when filing income tax returns, states the Internal Revenue Service; an employer does not deduct employment or federal income taxes on these contributions. Qualified medical expenses are any expenses the IRS lists as acceptable medical or dental expenses for income tax reporting purposes, including any medicines ordered by a doctor. Insulin is also a qualified medical expense. However, while IRS Publication 502 lists health insurance premiums as an acceptable medical expense, IRS Publication 969 explicitly states FSAs do not cover these costs.
FSAs are offered by employers as part of employee benefit plans, explains the IRS. These benefits are also known as salary reduction agreements because they are usually financed through voluntary employee contributions, although employers may also contribute to an employee’s FSA.