Flexible Spending Accounts, commonly referred to as "Flex" or "FSA" are a valuable tax saving tool which can be offered by employers, and come in two varieties...the Medical or Healthcare Flexible Spending Account and the Dependent Care Flexible Spending Account.
There has never been a better time than now to offer Flexible Spending Accounts in your organization, or to participate as an employee. In October 2013 the Internal Revenue Service (IRS) modified the Section 125 rule related to what is commonly called the "use it or lose it" rule for Medical FSA accounts, by giving employers a choice of continuing with the 2 1/2 month "grace period" or alternatively, to offer a new "rollover" option. If selected by the employer, the Rollover Option allows employees to rollover as much as $500 of unused funds for qualified healthcare expenses in the following year. This option differs from the Grace Period option where unused funds in one year can only be applied against expenses for the tax year in which contributions were made, leaving a burden upon employees to find expenses which had been paid by personal credit cards or cash.
Employees use their Medical Flex account to pay for medical, dental, vision, chiropractic, and prescription copays, and co-insurance - the portion of expenses, typically 20%, not covered by their insurance carrier. In addition to the above "out of pocket expenses" a Medical FSA has a cash-flow benefit in that once an employee's annual contribution election begins deducting from their paycheck, the entire amount elected can be "spent" on qualified expenses at any time, prior to fully funding the annual contribution. This is one reason why Medical Flex accounts are often used for larger qualified expenses for elective procedures like LASIK eye surgery, orthodontia (braces), designer eyewear purchases, etc. As of 2015, the IRS allows pre-tax contributions of up to $2,550 annually for Medical/Healthcare Flexible Spending Accounts and $5,000 annually for Dependent Care Flexible Spending Accounts.
Dependent Care Flex accounts while offering comparable tax savings percentages can provide participating employees, very lucrative tax savings since these types of expenses can be significant; however, they are somewhat more restrictive than Medical FSA accounts. In particular, only a state qualified provider of dependent care can be used for services, whether it be child day care, elder day care, or after-school care. Care provided by family members of employees does not qualify under such plans and employees are advised to check with local State Departments of Health, or Human Resources for qualified providers in their respective area.
Additionally, since costs for dependent care services are more predictable and somewhat static, there is no cash flow benefit as there can be with Medical FSA accounts. Employees can only pay for services with payroll deduction contributions to their Dependent Care FSA, minimizing any employer risk of loss due to employee resignation/termination.
Up to this point, we have covered the benefits of participation in Flexible Spending Accounts for employees; however, FSA's help employer groups realize greater tax savings due to an increased amount of payroll deducted on a pre-tax basis. Currently as of 2015, a tax savings of 7.65% can be realized on each participating employee, for each dollar contributed. This can result in sizeable tax relief, even for a small business owner. Alliance Insurance Group does not provide tax advice and recommends any employer seek counsel from qualified tax professionals prior to making a decision to offer FSA benefits in their organization. Find out how easy it is to establish an FSA and get an informed estimate of your tax savings potential based upon historical participation levels in your area. Give us a call.