FSA Tax Implications

Tax Implications Of Flexible Spending Accounts

Group Dynamics, Inc. estimates you can save 25 percent or more on the money you spend on eligible expenses by contributing to FSA's on a before-tax basis, depending on your tax bracket.

Federal and state income taxes: contributions for the Dependent Care Assistance Account and Medical Reimbursement Account will not be subject to state or federal income tax. 

Impact on Social Security: When you reduce your taxable income for Social Security purposes, you may also reduce by a small amount what you may claim in Social Security benefits at retirement. 

Earned Income Tax Credit:  Paying for benefits on a before-tax basis may put employees who are eligible for the Earned Income Tax Credit at a disadvantage when they file for federal income tax credits. If you fall into this category and believe-- after consulting a tax expert -- you would benefit from paying for coverage on an after-tax basis, please contact the Office of Human Resources. In this case, pre-tax contributions for benefits would then be included in your wages for calculating the Earned Income Tax Credit. 

Tax Credits and the Dependent Care Account

The IRS allows you to claim work-related, dependent care expenses for credit when you file your income tax return. In some cases, you may save more money through a tax credit than through the Dependent Care Assistance Account. 

If your dependent care expenses are high enough, you may be able to make use of both tax breaks. You cannot use both the tax credit and the Dependent Care Assistance Account for the same expenses. The IRS permits a dependent care credit of no more than $3,000 per child up to a maximum of $6,000 a year, and that this tax credit is offset dollar for dollar by any amount placed in a reimbursement account. For example, if your annual day care expenses for two children total $5,000 and you use the reimbursement account to pay for $3,000  of these costs, you may be eligible to take a Dependent Care Tax Credit of  $1,800 based on the difference between your FSA contribution and the maximum tax credit for which you qualify. 

The tax regulations regarding this benefit are complicated for those who use the Earned Income Tax Credit. Review the instructions published by the Internal Revenue Service carefully or consult a tax expert for advice. 

Effect on Withholding

Your participation in the FSA's may cause you to reconsider your payroll tax withholding rates. Please contact the Payroll Office (extension 4137) for more information.