FSA (Flexible Spending Account)

A flexible spending account (FSA) is a form of savings account that offers special tax benefits to the account holder. An FSA, also known as a "flexible spending arrangement," can be set up by a business for employees.

The account allows you to contribute a percentage of your pre-tax wages; businesses can also contribute to their employees' FSAs. Distributions from the account must be utilized to reimburse the employee for qualifying medical and dental costs.

Understanding Flexible Spending Account (FSA)

One of the primary advantages of a flexible spending account is that the amounts put to the account are deducted from your pre-tax earnings, lowering your taxable income. Contributions to an FSA on a regular basis might reduce your annual tax liability.

The IRS has the authority to limit the amount that can be contributed to an FSA account each year. The yearly contribution maximum for medical expense FSA accounts is $2,750 for each employee in 2020 and 2021.

If you're married, your spouse can additionally save up to $2,750 through their work. Employers can choose whether or not to contribute to an FSA; if they do, their contribution does not reduce the amount you are allowed to pay. Employer contributions are not taxed.

Pros and Cons of Flexible Spending Accounts

Pros

  1. Reimburse medical care payments: Pretax funds contributed to an FSA can be utilized for this purpose, which is defined as amounts paid for the diagnosis, cure, mitigation, treatment, or prevention of disease or ailments affecting any structure of the body.
  2. Pay eligible medical expenses for spouses and dependents: FSA owners can utilize the account to cover these as well as their own medical bills.
  3. Many types of medical equipment are covered: FSAs cover diagnostic equipment, bandages, and crutches. Expenses for prescription prescriptions, including over-the-counter (OTC) drugs for which you received a prescription, as well as insulin, can be reimbursed with FSA funds.
  4. FSAs can be used to reimburse the account holder for insurance plan deductibles, as well as to reimburse the account holder for co-payments for medical services.

Cons

  1. Some medical treatments or fees are not covered: Expenses for cosmetic surgery and things or services that are simply useful to general health, such as gym memberships, are not reimbursable.
  2. Funds include a "use it or lose it" clause: In most cases, you must use the funds in an FSA during the plan year. However, your employer may give one of two options: a "grace period" of up to 2 1/2 months to use the money in your FSA, or a carryover of up to $610 per year to spend in the next year, beginning January 1, 2023.
  3. Insurance premiums cannot be paid with it: FSAs can be used to pay for insurance deductibles, but they cannot be used to pay for insurance coverage.

How Flexible Spending Account (FSA) Works

One of the primary advantages of a flexible spending account is that the amounts put to the account are deducted from your pre-tax earnings, lowering your taxable income. As a result, making monthly contributions to an FSA can lower your taxable income.

Each year, the IRS limits the amount that can be donated to an FSA. For 2023, the annual contribution maximum for medical expense FSA accounts is $3,050 per employee.

If you're married, your spouse can contribute up to the annual contribution maximum through their employment as well. Employers may choose to contribute to an FSA, but they are not required to do so; if they do, their contribution does not affect the amount you are allowed to contribute. Employer contributions are not taxed.

Special Considerations

When the fiscal year closes or the grace period expires, any money remaining in your FSA is forfeited. As a result, you should carefully calculate the amount of money you intend to deposit into your account and how you intend to spend it throughout the year.

Key Takeaways

  • An FSA is a form of savings account in which employees can contribute a percentage of their monthly wages to cover health-care expenses.
  • Contributions to the account are taken from earnings and are exempt from income and payroll taxes.
  • Funds withdrawn from an FSA to pay for qualified medical expenses are not taxed.
  • The funds in an FSA must be spent by the end of the plan year, although employers can provide a grace period of up to two and a half months, until March 15 of the following year.
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