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What Are Flexible Spending Accounts?

“Gumby and flexibility are synonymous, and top athletes are praised for their Gumby-like or Gumbyesque prowess. The U.S. Marines use the phrase ‘Semper Gumby.’”  – Gumbyworld.com

In my last article I explained what Health Savings Accounts (HSAs) are, how they function, and the tax benefits associated with them. I used Flexible Spending Accounts (FSAs) as a negative foil to explain one of the benefits of HSAs. But make no mistake: FSAs serve a very real purpose, especially for employers.

Healthcare FSAs for Employees

For this section I’m going to borrow some phrasing from my last article. Just like HSAs, Healthcare FSAs “are savings accounts where the funds must be spent on qualified medical expenses. The advantage is that, like many retirement accounts, the funds are contributed pretax. This means that the funds contributed to an [FSA] are a direct reduction to an individual’s Adjusted Gross Income (and thereby are available before income tax or FICA are assessed). For example, assume a person contributes $2,400 to an [FSA] and has an effective tax rate of 25%. The [FSA] contribution will reduce their tax bill by $600 – effectively turning the $2,400 into $3,000!”

The major difference was that the FSA long had the “use it or lose it rule” – any contribution that was not used by the end of the year was lost. However, last month the IRS made a modification to the rule to allow for up to $500 to be carried over to the next year for Healthcare FSAs. This helps to give participants some buffer in their planning. The 2014 maximum annual contribution limit for FSAs is $2,500.

What Are Dependent Care FSAs?

A lesser known account is what are sometimes called a Dependent Care FSA or Dependent Care Assistance Account (DCA). These function the same way for tax purposes as Healthcare FSAs, but are used for dependent childcare expenses. This is a great tool for working parents. Please note that the new $500 carryover rule does not apply to DCAs. The 2014 maximum annual contribution limit for DCAs is $5,000.

Commuter Reimbursement Accounts

While not technically an FSA, it seems appropriate to mention Commuter Reimbursement Accounts as they function much in the same way for tax purposes. These are accounts employers can offer for their employees to use towards public transit or parking costs. The maximum monthly contributions are $250 for parking and $130 for mass transit.

Why Should Employers Offer These Benefits?

The benefits are pretty clear for employees, but what benefit is there to the employer beyond some degree of employee goodwill? Any amount an employee contributes is not subject to FICA (Social Security and Medicare) or income taxes. The employee does not pay income or the employee half FICA taxes and the employer does not pay the employer half of FICA taxes. Every dollar contributed to an FSA saves the employer 7.65 cents in FICA taxes.

This might not sound like a lot, but the effects can compound very quickly. Consider the following example for a company with 30 employees:

That is a savings of almost $6,000! And as the company continues to grow, so do the tax savings for employers. It is certainly something that employers should consider to see if it is appropriate for their situation.

Since the preceding information isn’t exactly edge-of-your-seat, thrill-a-minute reading I purposely kept it brief. If you would like to discuss whether implementing an FSA makes sense – with a company-specific/you specific evaluation by me, contact me and we can discuss your situation. I can also help you to understand which healthcare expenses are eligible for FSA spending and which are not. It can seem nonsensical and random – and a little assistance can go a long way. I don’t offer FSAs – I’m a CPA after all, not an insurance agent – and that’s why I can make an impartial assessment. If an FSA actually works for your company I can then direct you to qualified providers.

IRS Circular 230 Notice: To ensure compliance with requirements imposed by the IRS, we inform you that any federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of avoiding penalties under the Internal Revenue Code.