Eligible Expenses Under Cafeteria Plans: What’s Covered?

Managing an IRS Section 125 Cafeteria Plan requires balancing employee satisfaction with strict regulatory compliance. For human resources professionals and benefits administrators, no single question creates more daily friction than this: “Is this expense covered?“

When employees divert pre-tax dollars into Health Care Flexible Spending Accounts (FSAs) or Dependent Care Assistance Programs (DCAPs), they expect to use those funds effortlessly. However, the IRS maintains highly specific, constantly evolving rules regarding what constitutes a qualified expense. Approving ineligible claims can jeopardize your plan's tax-advantaged status, while incorrectly denying valid claims creates significant employee frustration.

By the end of this guide, you will have a clear, actionable understanding of the IRS frameworks that dictate eligible expenses, how recent legislative changes impact over-the-counter purchases, and which expenses are strictly excluded.

Key Takeaways:

• IRS Publication 502 serves as the primary standard for defining qualified medical expenses.
• Recent updates have permanently expanded coverage to include over-the-counter medications and menstrual care products.
• Dependent care expenses must specifically enable the employee to work.
• Certain costs, such as health insurance premiums and cosmetic procedures, are strictly excluded from FSA reimbursement.
• Ongoing education and benefits training are essential for compliant plan administration.

Learn More: What Is a Health Care FSA Under a Cafeteria Plan?

Understanding the Foundation of Section 125 Eligible Expenses

Under a Section 125 Cafeteria Plan, employees use pre-tax income to pay for specific benefits. Because these funds bypass federal income, Social Security, and Medicare taxes, the IRS tightly controls how they can be spent.

The Role of IRS Publication 502

When determining whether an expense is eligible for reimbursement under a Health Care FSA, administrators must turn to IRS Publication 502 (Medical and Dental Expenses). This publication outlines what the federal government considers a legitimate medical cost.

According to the IRS, a qualified medical expense must be primarily to alleviate or prevent a physical or mental defect or illness. It cannot be an expense that merely benefits the general health of an individual, such as standard vitamins or a gym membership for overall fitness. Understanding this distinction is the first step in properly adjudicating claims and maintaining the integrity of your benefits program.

Health Care FSAs vs. Dependent Care Assistance Programs (DCAP)

Cafeteria plans typically offer two distinct pre-tax accounts, and administrators must avoid confusing their eligible expenses:

1. Health Care FSAs: Reimburses qualified medical, dental, and vision expenses for the employee and their tax dependents.
2. Dependent Care Assistance Programs (DCAPs): Reimburses childcare or adult dependent care expenses specifically so the employee (and their spouse) can work, look for work, or attend school full-time.

Funds cannot be commingled. An employee cannot use their Health Care FSA to pay for daycare, nor can they use their DCAP to pay for a child's medical bills.

Learn More: Dependent Care Assistance Programs (DCAP) Explained

What Counts as a Qualified Medical Expense?

For Health Care FSAs, eligible expenses span a wide range of standard and specialized care.

Standard Medical, Dental, and Vision Costs

The most common uses of FSA funds involve routine healthcare interactions. Employees can confidently use their pre-tax dollars for:

• Medical care: Copayments, coinsurance, and deductibles associated with doctor visits, hospital stays, and surgeries.
• Prescription drugs: Medications prescribed by a licensed healthcare provider.
• Dental care: Cleanings, fillings, extractions, root canals, and orthodontia (braces). Teeth whitening, however, is considered cosmetic and is not covered.
• Vision care: Eye exams, prescription eyeglasses, prescription sunglasses, contact lenses, and contact lens solution. Corrective eye surgeries, such as LASIK, are also fully eligible.
• Medical equipment: Crutches, wheelchairs, blood sugar monitors, and CPAP machines.

The Expansion of Over-the-Counter (OTC) Medications

Historically, employees could only use FSA funds to purchase over-the-counter medications if they obtained a written prescription from their doctor. This rule created an immense administrative burden.

Fortunately, recent legislative changes permanently removed this requirement. Employees can now use their Health Care FSA funds to purchase OTC medications without a prescription. Eligible OTC products include:

• Pain relievers (ibuprofen, acetaminophen)
• Allergy and sinus medications
• Cold and flu remedies
• Heartburn medications
• First aid supplies (bandages, antibiotic ointments)

Menstrual Care Products as Permanent Additions

In addition to OTC medications, the IRS now officially classifies menstrual care products as qualified medical expenses. This is a permanent change that significantly enhances the usability of FSA funds for a large portion of the workforce. Employees can use their pre-tax dollars to purchase tampons, pads, liners, menstrual cups, and period underwear.

Navigating Dependent Care Eligible Expenses

Administering a DCAP requires a different regulatory lens. The IRS rules governing dependent care focus entirely on the purpose of the care rather than the medical need.

Who Qualifies for DCAP Care?

To use DCAP funds, the care must be provided to a “qualifying person.“ This generally includes:

• A dependent child under the age of 13.
• A spouse or adult dependent who is physically or mentally incapable of self-care and lives with the employee for more than half the year.

Eligible vs. Ineligible Dependent Care Costs

The golden rule of a DCAP is that the expense must allow the employee to earn an income.

Eligible DCAP expenses include:

• Daycare centers and nursery schools.
• Nannies or babysitters (provided the care is given while the employee is working).
• Before-school and after-school programs.
• Summer day camps.
• Adult daycare facilities.

Ineligible DCAP expenses include:

• Educational tuition (kindergarten and above).
• Overnight camps (even if the daytime portion allows the employee to work).
• Care provided by the employee's spouse or a relative who is claimed as a dependent.
• Late payment fees or activity fees charged by the care provider.

 Learn More: Eligible Expenses Under Cafeteria Plans: What’s Covered?

Common Exclusions: What Is NOT Covered?

Just as important as knowing what is covered is knowing what must be denied. Approving ineligible expenses can trigger severe IRS penalties.

Health Insurance Premiums

A fundamental rule of Section 125 Health Care FSAs is that they cannot be used to reimburse health insurance premiums. While employees can pay their portion of employer-sponsored health premiums on a pre-tax basis, this is done through a separate component of the cafeteria plan known as a Premium Only Plan (POP). FSA funds are strictly for out-of-pocket expenses, not premium payments for major medical, Medicare, or individual policies.

Cosmetic Procedures and General Wellness

The IRS explicitly excludes procedures and products designed solely to improve a person's appearance. Teeth whitening, cosmetic surgery (unless necessary to ameliorate a deformity arising from a congenital abnormality, injury, or disease), and hair removal treatments are not eligible.

Similarly, expenses for general health and wellness do not qualify. Standard daily vitamins, nutritional supplements, gym memberships, and weight loss programs are excluded unless specifically prescribed by a physician to treat a diagnosed medical condition (such as obesity or hypertension).

The “Dual-Purpose“ Dilemma (Letters of Medical Necessity)

Some expenses straddle the line between general wellness and medical care. These are known as “dual-purpose“ expenses. Examples include massage therapy, ergonomic office chairs, or specialized dietary foods.

For a dual-purpose expense to be eligible, the employee must submit a Letter of Medical Necessity (LMN) from a licensed healthcare provider. The LMN must state the specific medical condition being treated, the recommended treatment, and how long the treatment is required. Without a valid LMN on file, administrators must deny these claims.

Best Practices for HR Administrators

Ensuring your Section 125 plan remains compliant requires proactive management and a well-trained benefits team.

Educating Employees on Substantiation

The most effective way to minimize denied claims is through clear employee communication. Every expense reimbursed through a cafeteria plan must be fully substantiated. Ensure your employees understand that they cannot simply swipe an FSA debit card and forget about it. They must retain itemized receipts that show the provider's name, the date of service, a description of the item or service, and the total cost. Auto-substantiation at the pharmacy counter helps, but it does not eliminate the IRS requirement for record-keeping.

Leveraging Formal Training and Certification

Cafeteria plans sit at the complex intersection of tax law and human resources. Relying on assumptions or outdated knowledge exposes your organization to compliance failures, failed nondiscrimination testing, and potential audits.

For professionals managing these benefit structures, specialized HR certifications provide the critical knowledge needed to operate confidently. We strongly recommend formalizing your expertise through structured programs:

• Build a foundational understanding of plan design, documentation, and claims adjudication with the Cafeteria Plan Training & Certification Program.
• If your organization utilizes high-deductible health plans and tax-advantaged accounts, ensure your team understands the integration rules by completing the HSA Training & Certification Program.

Learn More: What Is a Health Care FSA Under a Cafeteria Plan?

Conclusion

Understanding exactly what qualifies as an eligible expense under a Section 125 Cafeteria Plan is non-negotiable for modern HR and benefits professionals. By familiarizing yourself with IRS Publication 502, staying current on legislative changes regarding OTC and menstrual products, and strictly enforcing substantiation rules, you protect your organization from compliance risks while providing a seamless benefits experience for your workforce.

To continue building a resilient, compliant, and highly valued benefits package, invest in your team's ongoing education and explore our comprehensive seminars and webinars today.