| Flexible Spending Accounts (FSAs) are one the | | | | starts or after the first contribution to the FSA is |
| numerous tax-advantaged financial accounts that | | | | received by the FSA vendor. The money that the |
| are authorized by the Internal Revenue Service | | | | employees contribute is not taxable because IRS |
| (IRS). With an FSA, employees may save a | | | | considers FSAs as ‘health insurance plans for |
| portion of their earnings to cover for qualified | | | | tax purposes’ and therefore, income received |
| medical expenses and/or dependent care | | | | from a health insurance plan is not taxable income. |
| expenses. As money deducted from an FSA is | | | | Upon termination of employment, employees are |
| not subject to payroll taxation, employees have | | | | not required to continue contributing to the FSA. |
| substantial payroll tax savings up to 20% thus | | | | As the taxable income decreases, employees can |
| lowering their taxable income. | | | | increase their take-home income. To illustrate the |
| FSAs are classified into: | | | | tax benefits of FSAs for employees, we assume |
| - Health Care FSA (HCFSA) | | | | that an employee of the company X earns |
| The Health Care FSA (HCFSA) covers for | | | | $50,000 for the year and contributes $5,000 to |
| qualified medical and health care expenses that | | | | an FSA. By contributing 10% of annual salary to |
| are not covered or are partially covered by | | | | an FSA, the taxable income is reduced to |
| health, dental or vision insurance or by Federal | | | | $50,000-$5,000 = $45,000. If the employee pays |
| Employees Health Benefits (FEHB) plan. | | | | taxes equal to 30% for the year, then he saves |
| Common medical coverage includes: doctors’ | | | | $45,000 x 30% = $1,500. Plus the money |
| fees; hospital services; nursing services; labs fees; | | | | contributed to FSA is not subject to taxation |
| long-term care services; acupuncture treatments; | | | | when withdrawn provided it is used for qualified |
| alcohol and drug addiction treatments; | | | | medical or dependent-care expenses. |
| smoking-cessation programs; vasectomies, | | | | Employers are also favored by the FSAs because |
| hysterectomies and birth control; hearing aids; | | | | they are not required to pay their portion of |
| wheelchairs; guide dogs; crutches; prescription | | | | Social Security taxes which is equal to 7.65% of |
| medicines; and insulin. | | | | the taxable income of each employee. To |
| - Limited Expense Health Care FSA (LEX HCFSA) | | | | illustrate the tax benefits of FSAs for employers, |
| The Limited Expense Health Care FSA (LEX | | | | we assume on the above example that the |
| HCFSA) covers for qualified dental and vision care | | | | company X employs 10 people with an annual |
| expenses that meet the IRS definition of medical | | | | payroll of $500,000. Normally, employers would |
| care. Only employees who enroll in a Federal | | | | pay $500,000 x 7.65% = $38,250 to Social |
| Employees Health Benefits (FEHB) plan with a High | | | | Security taxes. However, with the |
| Deductible Health Plan (HDHP) and a Health | | | | employees’ contribution to the FSAs that |
| Savings Account (HSA) are eligible for LEX | | | | equals $5,000 x 10 = $50,000, the company’s |
| HCFSA. | | | | taxable payroll is reduced to $450,000 for the |
| Expenses covered under LEX HCFSA are | | | | year. The company pays $450,000 x 7.65% = |
| cleanings, fillings, crowns, and orthodontics for | | | | $34,425 to Social Security taxes and saves |
| dental care and eyeglasses, contact lenses, | | | | $38,250 - $34, 425 = $3,825 in annual taxes. This |
| refractions and vision correction procedures for | | | | amount combined with the $1,500 tax savings per |
| vision care. | | | | employee results in a total tax reduction for the |
| - Dependent Care FSA (DCFSA) | | | | company from the FSA equal to $1500 x 10 = |
| The Dependent Care FSA (DCFSA) covers for | | | | $15,000 (for all 10 employees) + $3,825 = |
| eligible dependent care expenses such as child | | | | $18,285 for the year. |
| care for children under 13 years old or day care | | | | Another major advantage of medical FSAs is that |
| for elderly parents or anyone who is claim as the | | | | it provides coverage of over-the-counter (OTC) |
| employee’s dependent based on physical or | | | | medical products and drugs. Because of that, |
| mental disability. | | | | more and more consumers are expressing their |
| Advantages of FSAs | | | | interest in flexible spending accounts, thus |
| One of the major advantages of medical FSAs is | | | | considerably expanding the range of FSA-eligible |
| their tax benefits. IRS guidelines allow employees | | | | purchases. |
| to contribute to FSAs using their pre-tax income. | | | | Some important considerations |
| In doing so, they can save on federal and state | | | | Although flexible spending accounts lower the |
| income taxes as well on their portion of Social | | | | taxable income of employees who participate in |
| Security taxes on the amount they authorize | | | | such plans, they also involve a risk to employers |
| their employer to put in the FSA from | | | | because of pre-funding. The amount of money |
| withdrawing from their paychecks on an annual | | | | that employers lose because of pre-funding may |
| basis. | | | | be partially or more than compensated by the |
| By setting aside a specific amount per year for a | | | | amount of money that is not spent in |
| medical FSA, the entire amount is immediately | | | | employees’ FSA accounts by the end of the |
| available, either on January 1st when the program | | | | plan year and grace period. |