A flexible spending account (FSA) is a benefit that employers offer to employees that allow a fixed amount of pre-tax wages to be set aside for eligible expenses. The expenses that are eligible depend on the different types of FSA accounts:
- Dependent care flexible spending account
- Child care flexible spending account
- Health care flexible spending account
- Cafeteria plans – A plan that allows employees to choose between two or more benefits
FSAs allow employees to make pre-tax salary contributions to pay for eligible expenses, which helps to make these out-of-pocket expenses more affordable. By having a flexible spending account, an employee can save up to 20-40% on covered expenses, resulting in immediate tax savings on items such as health insurance premiums; non-reimbursed medical, vision, and dental care; and child/dependent care expenses. Also, since the contributions are taken out before the employee’s wages are taxed, it reduces the employee’s taxable income, which has the effect of increasing the employee’s overall disposable income.
Furthermore, FSAs are tax-free from the first dollar contributed, so employees do not have to meet a minimum amount in order to receive the tax advantage. Therefore, employees save on:
Federal income tax
State and local tax in most states
Flexible spending accounts can be changed annually, as each plan year is separate from the other. The separate plan years mean that an employee must re-enroll in the FSA each plan year and make any elections for that year. This allows for employees to make different elections each year, depending on the type of FSA as well as the amount that is set aside for the account.
Because tax law and flexible spending accounts can be difficult to understand, it is advisable that you obtain the advice of a qualified employment attorney. A lawyer who is knowledgeable about tax law can help you understand current tax law, and how a flexible spending account can affect your income taxes.