Tax Tips: Flexible Spending Accounts

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Many companies allow employees to set aside a specific dollar amount from their salary each year in a flexible spending account (FSA) to pay for qualifying medical expenses.

You choose to set aside $5,000 in a medical FSA. As you incur medical expenses you would either submit the bills to be paid by the FSA, or request reimbursement from the FSA, up to the $5,000 set aside.

Monies contributed to an FSA are pre-tax for federal income tax (and state income tax in most cases) and FICA (Social Security and Medicare) tax purposes.

If your annual salary is $75,000 and you set aside $5,000 in a medical FSA, the federal wages reported on your Form W-2, as well as the Social Security and Medicare wages, will be $70,000. If you are in the 25% bracket, this $5,000 will save you $1,633 in federal income and FICA taxes, plus possibly a few hundred in state income taxes.

The savings don’t end there, though. Because contributions to a medical FSA reduce taxable wages they also reduce Adjusted Gross Income, and therefore may increase deductions and credits that are affected by AGI.

Under a medical FSA you get an above-the-line deduction for 100% of qualified medical expenses paid through the plan. You do not have to reduce the expenses by 7.5% of your AGI.

Of course medical expenses paid through an FSA are not included in medical costs deducted on Schedule A.

New Jersey tax pro Robert D. Flach has been preparing 1040s for individuals since 1972.

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