By: Lisa M. Wood, CPA, MT - Director of Tax
Are you eligible for Flexible Spending Accounts through work? The two most popular plans are for health care costs and for dependent care costs. Learn about how much you could save in taxes by taking advantage of these plans!
A Health Care Flexible Spending Account (FSA) is an employer-sponsored health care benefit. In 2023, employees can elect a pre-tax salary reduction of up to $3,050 to go into their FSA. This is funded with regular payroll deductions each pay period. The employer may also contribute to the employee’s FSA. It works like a savings account and is used to pay or reimburse qualified medical related expenses.
FSAs are “use-it-or-lose-it” plans, meaning that any remaining balance at the end of the year cannot be refunded. However, the plan does have the option to provide either a grace period or a carryover amount. The grace period is 2 ½ months and any expenses incurred during that time can be paid from the balance left at the end of the previous year. The carryover option permits the plan to provide an amount of the unused balance ($610 for 2023) to be paid for qualified medical expenses incurred in the following year.
FSAs have several benefits including:
- Contributions are not subject to income or employment taxes.
- Employer contributions are excluded from gross income.
- Reimbursements for qualified medical expenses are not subject to tax.
- The FSA can be used to pay for medical expenses even if the funds have not been deposited into the account yet.
- Easy to use – plans often provide a debit card to pay for expenses rather than pay-out-of-pocket and submit receipts for reimbursement.
A qualified medical expense is an amount paid for the “diagnosis, cure, mitigation, treatment, or prevention of disease, or for the purpose of affecting any structure or function of the body,” (Internal Revenue Code §213(d)). Expenses can be paid on behalf of the taxpayer, the taxpayer’s spouse, any dependents claimed on the taxpayer’s income tax return and taxpayer’s children under the age of 27 at the end of the tax year.
Eligible expenses include:
- Doctor’s office co-payments
- Hospital visits
- Prescription medication
- Over-the-counter medication
- Prescription eyeglasses and contact lenses
- First-aid supplies (such as bandages, antibiotic ointment, etc.)
- Menstrual care products
- Medical diagnostic products (such as blood sugar test kits)
The tax savings can be quite substantial. For example, a household with the median US income of $75,000 would save almost $1,000 annually in income taxes and payroll taxes by electing the full amount of the contribution ($3,050 in 2023).
Similar to the Health Care FSA, a Dependent Care FSA allows employees to set aside pre-tax dollars to pay for qualified costs of dependent care. Taxpayers can contribute up to $5,000 per household ($2,500 if married filing separately). Both spouses must be employed, attending school full-time or looking for work. The money in the FSA can be used for expenses for a dependent under the age of 13, a spouse who is unable to work and care for themselves, or another adult dependent who is unable to care for themselves (provided they are claimed as a dependent on the tax return).
Qualified expenses include:
- Institutional-setting daycare or adult daycare
- In-home care (such as a babysitter or nanny or au pair)
- Before and after-school care
- Summer day camps (but not overnight camp)
The same household mentioned above with $75,000 of income would save almost $1,500 annually in taxes by contributing the maximum $5,000 to the plan.
Like the Health Care FSA, there is a “use-it-or-lose-it” policy. Unlike the Health Care FSA, Dependent Care FSAs are not pre-funded. Taxpayers pay for the dependent care expenses out-of-pocket and then receive reimbursement based on how much has been withheld from their paycheck.
Our experienced team at Buckingham Advisors is here to help you! If you have questions related to your specific situation with flexible spending accounts, please reach out to one of our team members.