Reviewed by a licensed benefits professional. Last reviewed: September 29, 2026.
A Section 125 FSA is not a separate product. It is a benefit that runs inside a Section 125 cafeteria plan, which is the written plan that lets employees pay for benefits before tax. If you offer a health FSA, you already have the plan or you are about to need one.
Most employers add an FSA for the payroll tax savings and stay for the recruiting value. The catch is a rule that puts the employer, not the employee, on the hook for early spending.
Key facts (2026):
- The 2026 health FSA salary reduction limit is $3,400 per employee, and the carryover cap is $680 (IRS Revenue Procedure 2025-32, 2025).
- Employees can exclude up to $7,500 of dependent care assistance for 2026, or $3,750 if married filing separately (IRS Publication 15-B, 2026).
- FICA is 7.65% on the employer side and 7.65% on the employee side, and pre-tax FSA contributions avoid both (IRS Publication 15, 2026).
- A plan fails if more than 25% of the total nontaxable benefits go to key employees (IRS Publication 15-B, 2026).
- Health FSA money can be used only for expenses incurred during the coverage period, and unused balances are forfeited unless a carryover or grace period applies (Proposed Treas. Reg. 1.125-5, 2007).
What Is a Section 125 FSA?
A Section 125 FSA is a health flexible spending account that an employer offers through its Section 125 cafeteria plan. Employees choose a yearly amount before the plan year starts, and it comes out of pay before income tax and FICA. They spend it on qualified medical costs.
Section 125 of the Internal Revenue Code is the rule that lets employees choose between cash and certain benefits without being taxed on the cash. Summit Health Benefits' Section 125 cafeteria plan guide explains the full structure.
Two kinds of FSA usually sit inside the plan:
| FSA type | What it pays for | 2026 limit |
|---|---|---|
| Health FSA | Copays, deductibles, prescriptions, dental, vision | $3,400 salary reduction, $680 carryover cap |
| Dependent care FSA | Child care and adult day care so the employee can work | $7,500, or $3,750 if married filing separately |
The health FSA limit comes from IRS Revenue Procedure 2025-32. The dependent care figure comes from IRS Publication 15-B (2026). Summit's health FSA contribution limit and dependent care FSA limit guides cover each in depth.
The IRS has not published the 2027 health FSA limit as of this review. Watch for the annual Revenue Procedure before your plan year opens.
How Does an FSA Fit Inside a Section 125 Plan?
An FSA fits inside a Section 125 plan as one of the benefit choices in the written plan document. The plan document names the FSA, sets the plan year, and states the election rules. Without a plan document, the FSA contributions are taxable.
Four rules shape how the FSA runs day to day:
- Elections are made before the year starts. Employees pick an amount in advance, and it is generally locked for the plan year, per 26 CFR 1.125-4.
- Changes need a qualifying event. Marriage, divorce, a birth, or a change in dependent care cost can allow a change. A change of mind does not.
- Expenses must be incurred in the coverage period. The Proposed Treas. Reg. 1.125-5 allows reimbursement only for expenses incurred while the employee is a participant.
- Unused money is forfeited. The use-or-lose rule applies unless the plan adds a carryover or a grace period.
Summit's guide to how to set up a Section 125 plan walks through the plan document, and the Section 125 election change rules page lists the qualifying events.
What Is the Uniform Coverage Rule for a Health FSA?
The uniform coverage rule requires the full yearly health FSA election to be available to the employee at all times during the coverage period, regardless of how much has been paid in. Proposed Treas. Reg. 1.125-5(d) sets the rule, and the employer bears the risk.
That means an employee who elects $2,400 can be reimbursed $2,400 in January, even though only one paycheck of contributions has arrived. If the employee then quits, the employer usually cannot collect the difference.
Worked example: the uniform coverage risk
Take a hypothetical employer with 10 FSA participants. One elects $2,400 ($200 a month), has a $2,400 procedure in February and leaves on February 28.
| Line | Amount |
|---|---|
| Reimbursed to the departing employee | $2,400 |
| Contributions collected through February | $400 |
| Employer shortfall on that account | $2,000 |
| Forfeitures from the other 9 accounts (assume $150 each) | $1,350 |
| Net employer cost for the year | $650 |
Forfeitures are the unused balances left in other accounts at year-end. Proposed Treas. Reg. 1.125-5(o) lets the employer use them to defray plan costs, keep them, or return them to participants on a reasonable and uniform basis. The dollar figures above are invented to show the mechanics, not a forecast.
Summit's uniform coverage rule guide covers this risk in more detail.
How Much Does a Section 125 FSA Save an Employer in FICA?
A Section 125 FSA saves an employer 7.65% in FICA on every dollar employees put into it, per IRS Publication 15 (2026). On a 10-person team electing $1,200 each, that is $918 in employer FICA a year, and employees save the same amount on their side.
| Line | Amount |
|---|---|
| Employees in the FSA | 10 |
| Average yearly election | $1,200 |
| Total pre-tax FSA contributions | $12,000 |
| Employer FICA avoided (7.65%) | $918 |
| Employee FICA avoided (7.65%) | $918 |
| Combined payroll tax avoided | $1,836 |
Income tax savings for employees come on top of that. Summit's FICA tax savings guide shows the same math across other election sizes.
The Summit Health Benefits $35 per enrolled employee per month admin fee is paid out of the FICA savings the whole plan creates, not from one benefit line, and the employer nets about $56 to $101 per enrolled employee per month. FSA elections alone are a small part of that total. Premium contributions do most of the work.
Should Your FSA Have a Carryover or a Grace Period?
Your FSA can have a carryover of up to $680 into the next plan year, or a grace period of up to 2 months and 15 days, but not both, per IRS Notice 2013-71. Either option reduces forfeitures, which means fewer dollars back to the employer.
| Feature | Carryover | Grace period |
|---|---|---|
| Limit | Up to $680 for 2026 | Up to 2 months and 15 days |
| What it extends | Unused dollars | Time to spend the old balance |
| Effect on forfeitures | Smaller | Smaller |
| Effect on HSA eligibility | Blocks HSA unless the FSA is limited purpose | Blocks HSA unless the balance was zero at year-end |
The carryover cap comes from IRS Revenue Procedure 2025-32. The HSA rule comes from IRS Publication 969, which says an employee covered by a high deductible health plan and a general purpose health FSA generally cannot make HSA contributions. A limited purpose FSA that pays only dental and vision keeps HSA eligibility. Summit's FSA grace period vs carryover guide and HSA vs FSA comparison help you pick.
What Nondiscrimination Rules Apply to a Section 125 FSA?
A Section 125 FSA must not favor key employees. IRS Publication 15-B (2026) says a cafeteria plan fails when more than 25% of the total nontaxable benefits go to key employees. Key employees include certain officers and owners.
Small owner-run businesses trip this rule more than they expect. If two owners and three staff share the plan, the owners' elections can push past 25% of the benefits. Summit's Section 125 nondiscrimination testing guide explains the tests, and the simple cafeteria plan safe harbor is the small-employer way around them.
Free copy-paste FSA announcement for your team
Subject: Health FSA open enrollment: pick your amount before the deadline
>
Hi team, our health FSA lets you pay for eligible medical, dental and vision costs with pre-tax pay. The 2026 limit is $3,400. You choose your yearly amount before the plan year starts, and it generally cannot change mid-year unless you have a qualifying event like marriage or a birth. Please choose an amount you expect to spend. Unused money may be forfeited, subject to our plan's carryover rule. Elections are due by [date] to [name].Get Your Free Plan Design
Get a Side-by-Side of Your Benefits vs a Section 125 Setup With an FSA
A Summit Health Benefits specialist will show what an FSA and pre-tax premiums would change in your payroll, and what the uniform coverage rule could cost you.
Frequently Asked Questions
What is a Section 125 FSA?
Is an FSA the same as a Section 125 plan?
Can employees change their FSA election mid-year?
What happens to unused money in a Section 125 FSA?
Does an FSA lower payroll taxes for the employer?
Can an employee have both an FSA and an HSA?
Sources
IRS Revenue Procedure 2025-32 (2026 inflation-adjusted amounts); IRS Publication 15-B, Employer's Tax Guide to Fringe Benefits (2026); IRS Publication 15, Employer's Tax Guide (2026); IRS Publication 969, Health Savings Accounts and Other Tax-Favored Health Plans; 26 CFR 1.125-4, Permitted election changes; Proposed Treasury Regulation 1.125-5, Flexible spending arrangements, Federal Register (August 6, 2007); IRS Notice 2013-71 (carryover and grace period); Internal Revenue Code Section 125. Summit Health Benefits pricing: $35 per enrolled employee per month, paid from FICA savings.