If offered by your employer, flexible spending arrangements (FSAs) provide an easy way to lower your taxable wages. As the end of 2020 nears, here are some rules and reminders to keep in mind.
A pre-tax contribution of up to $2,750 to a health FSA is permitted. You save taxes because you use pre-tax dollars to pay for medical expenses that might not be deductible. Normally these expenses would be an itemized deduction. The standard deduction was raised as part of 2017’s tax reform. This means fewer people receive a benefit from expenses that fall under the umbrella of itemized deductions. Even if you do itemize, medical expenses must exceed a percentage (7.5%) of adjusted gross income before being counted. Additionally, the amounts that you contribute to a health FSA aren’t subject to payroll taxes.
Your plan should have a listing of qualifying expense and documentation needed for reimbursement. Typical expenses include deductibles, copays, and prescription medications.
To avoid any forfeiture of your health FSA funds because of the “use-it-or-lose-it” rule, you must incur qualifying medical expenditures by the last day of the plan year, unless the plan allows an optional grace period. A grace period can’t extend beyond the 15th day of the third month following the close of the plan year. For a plan with a calendar year end, the grace period ends on March 15.
Some plans allow a carryover of a participant’s unused health FSA funds of up to $550. Amounts carried forward under this rule are added to the $2,750 maximum that you elect to contribute for 2021. An employer may allow a carryover or a grace period, but not both features. Check with your HR Department to see which feature your plan allows.
Examining your year-to-date expenditures, along with any expected changes, will help determine how much to set aside for next year.
Dependent care FSAs
Some employers also allow employees to set aside funds on a pre-tax basis in dependent care FSAs. A $5,000 maximum annual contribution is permitted ($2,500 for a married couple filing separately).
These FSAs are for a dependent child under 13, or a dependent or spouse who is physically or mentally incapable of self-care who also lives with the taxpayer for more than half the year.
Like health FSAs, dependent care FSAs are also subject to a use-it-or-lose-it rule. Unlike health FSAs, dependent care FSAs do not allow for the carryover of unused funds.
SPECIAL RULE FOR 2020: Because of COVID-19, the IRS has temporarily allowed increased flexibility to make mid-year changes during the 2020 calendar year. These include the opportunity to increase or decrease this year’s FSA contributions.
Please reach out to Wegner CPAs if you’d like to discuss FSAs in greater detail.