A flexible spending account, or FSA, is a pre-tax expense account that many employers offer for employees' benefit. These bills allow you to pay necessary expenses without paying taxes on the money you have invested.
Find out what a flexible spending account covers and how you can reduce your tax burden by using one to pay for your daily expenses.
What is a Flexible Spending Account (FSA)?
Flexible Spending Accounts (also known as FSA or Flexible Spending Arrangements) are savings programs designed to help you pay for the expenses you need, such as:
Child care expenses: child care payments
Medical and dental expenses: payments, deductibles, and prescriptions.
Medical equipment: crutches, hearing aids, glasses, or blood glucose test kits
Money from a flexible spending account cannot be used to pay insurance premiums.
Flexible spending accounts should be established through your employer so that you can allocate pre-tax dollars to help pay for the expenses you need. This money is taken from your salary and deposited in a separate account. Your employer can contribute but is not obligated to do so.
Each flexible spending account is limited to $2,750 per employer per year. If you are married, your spouse may also have a flexible spending account of up to $2,750 from your employer.
How the flexible spending account (FSA) reduces your tax bill
Any contribution you make to an FSA plan is reserved pre-tax. The amount of the benefit is deducted from the gross pay before the federal income tax is calculated.
This means that you will not have to pay income tax for the money you contribute to the flexible spending account. As soon as the money enters the flexible spending account, you must send receipts for the qualifying expenses before they can be reimbursed. Flexible spending accounts have scheduled repayment plans, usually chosen by your employer.
Besides reducing the income tax you pay, flexible spending account contributions also reduce your wages or FICA (Federal Insurance Contribution Act) taxes, which will be a good saving for you to receive a reduced payment.
A major disadvantage of a flexible spending account
One of the main disadvantages of a flexible spending account is that you have to use up all the money you set aside each year. Otherwise, you will lose the right to contributions. Your employer is not required to repay your plan balance.
There are several ways to avoid losing all your money, depending on the structure of the flexible spending account:
The IRS will allow flexible spending accounts to pay the claims within two and a half months of the end of the plan's benefit year.
You can transfer up to $500 that has not been used in the flexible spending account to next year's account.
The plan administrator is not required to do any of these things. You can ask your HR representative if any part of the flexible spending account money can be carried over to the following year.
Save on multiple types of expenses.
Flexible spending accounts are available in two varieties. A flexible medical spending account can cover medical, vision, and dental expenses that are not covered by another health care plan. Flexible spending accounts for dependents help cover the day-to-day costs of child care.
Medical Flexible spending account
Due to the rising costs of healthcare and prescriptions, medical flexible spending accounts are particularly beneficial. You can use the money to pay for consultations, prescriptions, and other medical bills that are not covered by another health, vision, or dental plan.
You can also use a medical flexible spending account to cover over-the-counter medical bills or alternative treatments, such as:
Acupuncture
Contraception
Denture cleaner
Fertility treatments
Lasik
Menstrual care products
Orthodontics
Over-the-counter medications
Treatment of alcoholism
For most taxpayers, using a flexible spending account is the only way to reduce the tax burden on the money you use to pay your medical bills. Medical expenses are only tax-deductible when the expenses exceed 7.5% of adjusted gross income. And you can only deduct these if you itemize your deductions instead of taking the standard deduction.
Medical flexible spending accounts start by reducing taxable income. Therefore, contributions to a medical flexible spending account can be used to cover expenses, many of which would not otherwise be deductible.
Dependent Care flexible spending account
Flexible spending accounts for dependents are used to separate pre-tax dollars to pay for skilled employee care costs. This may include:
Afterschool
Babysitter, au pair, or nanny
Custodial elderly care
Daycare for the elderly or disabled
Field day
Nursery or kindergarten
These expenses must:
Allow you to work, look for work or go to school full time
Be for a dependent in your care
If you are using the flexible spending account to pay for dependent care, you generally will not be able to claim the dependent care tax credit.
Bottom Line
Flexible spending accounts are a flexible way to reduce your tax burden by paying for large and necessary expenses, such as health costs, medical supplies, prescriptions, and the care of your dependents.
However, since flexible spending account contributions don't necessarily carry over to the next year, you will get most tax benefits if you only contribute what you know you can use before the end of the year. If you use all the money in the flexible spending account each year, you will get the maximum tax benefits.
Using a flexible spending account to pay child care expenses may also prevent you from receiving certain deductions or credits on your tax return. Consult with a professional such as FLYNN FINANCIAL GROUP, INC. to find out which option will save you the most taxes.
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