Plain version: a health flexible spending arrangement (FSA) is a pre-tax envelope filled from the paycheck for the year's expected medical costs. Money left at the end of the year is generally lost, so employees try to elect only what they expect to spend.
Funding: health FSAs are employer-established plans, usually funded by voluntary salary reduction agreements; the employer may also contribute. The employee pays no federal income or employment tax on those amounts, so nothing is deducted on the tax return.
Uniform coverage: the full annual election must be available at any time during the coverage period, no matter how much has been withheld so far. Example: Eva elects $1,800 for the calendar year, withheld at $150 a month. In January, after only $150 is withheld, she has a $1,200 qualified expense. The FSA can reimburse the full $1,200 now. Limiting her to what has been withheld would treat the FSA like a savings account, which is how an HSA works.
Unused money: FSAs are generally use-it-or-lose-it, but a plan may provide either a grace period of up to 2½ months after the plan year ends or a carryover, not both. A carryover does not reduce the next year's maximum salary reduction, and a plan may set a carryover lower than the IRS maximum. The employer may not refund any part of the balance to the employee.
What it pays, and the HSA tie-in:
Pays: copayments, over-the-counter medicine whether or not prescribed, and menstrual care products.
Cannot pay: health insurance premiums, long-term care costs, or amounts covered under another health plan.
With an HSA: a general purpose health FSA ends HSA eligibility, even with a small election. A limited-purpose FSA that pays only items such as dental, vision and preventive care, or a post-deductible FSA, does not.