What You Need to Know About FSAs

PHOTO: Money deducted for a medical flexible spending account can be used to pay for over-the-counter drugs among other things.

Workplace benefits not only provide you and your family with much-needed services, but some of them also can help cut your federal tax bill. One of the most popular benefits is a flexible spending account, often referred to as an FSA.

Companies typically offer two types of spending accounts. With a dependent-care FSA, an employee sets aside money to help pay costs typically associated with putting the kids in day care so mom and dad can work.

But even more workers opt for a medical FSA, in which they can set aside money to pay for routine items such as health insurance copays, uninsured treatments such as vision care or even over-the-counter drug purchases.

In both cases, the money is taken out through regular, equal payroll deductions. In both cases, the FSA deductions come out of a worker's paycheck on a pretax basis. That means less of your earnings are subject to tax.

As helpful as these accounts are, they have one big drawback: the use-it-or-lose-it requirement that costs workers millions of dollars each year. The law requires workers to spend FSA contributions by the end of the company's benefit year, which in most cases is Dec. 31. Any leftover account amount is forfeited.

Claims deadline extended

In recent years, however, workers have received some relief here. Spending-plan participants now are allowed to make claims against their accounts for up to two months and 15 days after the end of their benefit year. This grace period means employees on a calendar benefit year now can use their prior-year FSA contributions for expenses incurred as late as March 15 of the following year.

The one downside: This is allowed by the Internal Revenue Service, but companies aren't required to extend their FSA withdrawal periods. Check with your company's payroll or human resources department to see if you have some extra time to spend up your FSA account.

Medical-spending account owners are likely to benefit most from the change, but the rule also applies to dependent-care accounts. The reality is, however, that workers rarely have excess dependent-care-account money at the end of the benefit year.

Through 2012, individual companies set the limit on how much could be contributed to a medical account, but beginning in 2013 and going forward, a provision in the Affordable Care Act reduced the medical FSA limit to $2,500. There already is a firm federal limit of $5,000 on the annual contribution for dependent-care accounts. This is a family limit, meaning that even if both parents have access to flexible-care accounts, their combined contributions cannot exceed $5,000.

The pretax account money can be used to help pay the costs of any caregiver providing services while you're at work. This includes the nursery school for kids, a day camp during the summer or the home health aide looking after a disabled spouse.

"I suppose the IRS emphasized the medical side because that's where people are more likely to have dollars left at the end of the year," says Bob D. Scharin, senior tax analyst from the Tax & Accounting business of Thomson Reuters in New York. "I figure that people who use the dependent care benefit have probably already used up all of the funds in that account by the year's end."

Coordinating across benefit years

In addition to providing more time for claiming FSA reimbursements, the grace period also allows employees to coordinate two years of FSA contributions for maximum benefit, says Scharin.

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