[This is part of a Special Series on the tax changes made by the One Big Beautiful Bill Act, which was enacted in July 2025. It includes a wide range of changes to individual and corporate taxes, deductions, credits, forms and other topics, that affect tax filing starting this year into the future.]
The tax law provides benefits to employees who participate in flexible spending accounts (FSAs) offered by their employers. Now the One Big Beautiful Bill Act (OBBBA) broadens the scope of these tax-favored accounts.
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Background: With either one of the two types of FSAs, the participating employee funds the account with pre-tax dollars. Therefore, the employee saves both income tax and payroll taxes on plan contributions. Plus, there’s no tax on amounts withdrawn if they are used to pay for qualified expenses. Similarly, the employer saves on its share of payroll taxes.
The two types of accounts are healthcare FSAs and dependent care FSAs.
- Healthcare FSAs: After amounts are deposited in the account, the employee pays qualified healthcare expenses as needed throughout the year. The annual inflation-indexed limit on contributions for 2025 is $3,300. Tax-free withdrawals may be made for expenses incurred by an employee, his or her spouse, and dependents age 26 or younger.
The list of qualified expenses generally mirrors those expenses normally deductible as medical expenses on a personal return. For instance, an employee may use a healthcare FSA to pay insurance co-payments, co-insurance and deductibles, dental and vision care and prescription drugs, etc. - Dependent care FSAs: A dependent care FSA operates much like a healthcare FSA except that withdrawals must be used for qualified dependent care expenses. The funds can cover expenses of caring for a child under age 13 or a dependent physically or mentally incapable of self-care (e.g., an elderly relative with Alzheimer’s Disease).
The annual limit for contributions to a dependent care FSA has been stuck at $5,000, without indexing, for decades. Qualified dependent expenses generally include those allowing the employee (and spouse, if married) to be gainfully employed. This includes fees for day care centers, nursery schools, babysitters, and summer day camp.
Major change: The OBBBA increases the contribution limit for dependent care expenses to $7,500, beginning in 2026. This gives participating employees more leeway as dependent care costs continue to escalate. On the other side, employers should accommodate new choices for 2026 payroll withholding.
Finally, in the past employees were often hampered by the “use-it-or-lose-it rule” requiring FSA participants to use funds in their accounts by year-end or forfeit them. Under current law, employers can offer one of two options.
- An employer can provide participating employees with a 2½-month grace period. In other words, employees have until March 15 of the year following a calendar plan year to use any remaining funds in their FSA before they are forfeited.
- Alternatively, an employer may allow FSA participants to carry over up to $500 of unused funds to next year (indexed to $660 in 2025). However, any excess is forfeited.
Either the grace period or the carryover may be allowed, but not both. Therefore, an employer must decide which option, if any, to offer as a way around the use-it-or-lose-it rule.
Practical approach: Meet with small business clients to discuss their preferences for the upcoming year. Provide whatever guidance is needed.
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