With a Flexible Spending Account,
you can set aside a portion of each paycheck for eligible expenses.
This amount is deducted from your paycheck before taxes are
calculated.
By pre-taxing these expenses you may realize tax savings six different ways: federal income taxes, payroll taxes, alternative minimum tax, child tax credit, education tax credit, and the state income taxes.
1 - Federal Income Taxes
A family contributing $7,000 to an FSA might see the following federal income tax savings.
| Tax Bracket |
Federal Tax Savings
|
| 10% |
$700 |
| 15% |
$1,050 |
| 25% |
$1,750 |
| 28% |
$1,960 |
| 33% |
$2,310 |
| 35% |
$2,450 |
2 - Payroll Tax Savings (FICA)
An FSA may also reduce the amount
you pay in Payroll Tax - specifically FICA tax. FICA
stands for Federal Insurance Contributions Act. The tax pays for Social
Security and Medicare. FICA is a payroll tax, and withheld by your
employer. Both the employee and employer pay the same amount of payroll
tax (FICA Tax). You will save 7.65% for every dollar you contribute
into a
Flexible Spending Account.
For people earning more than $97,500 in W2
income, the FICA tax savings falls to .77%. Be sure to put your FSA
dollars into the account of the lower earning spouse.
Example - a family contributing $7,000 into a Flexible Spending Account will generate:
- $535.50 in Payroll Tax Savings for the family
- $535.50 in Payroll Tax Savings for the employer
3 - Alternative Minimum Tax Savings (AMT)
The Alternative Minimum Tax (AMT) is a separately figured tax that
eliminates many deductions and credits, thus increasing tax liability
for an individual who would otherwise pay less tax. The AMT is
triggered by large amounts of itemized deductions. The AMT sets a rate
of either 26% or 28% for income subject to this tax.
Large amounts of
Medical Expense Deductions may help push you into this extra tax. A
Flexible Spending Account helps reduce your possible exposure in two
ways:
- Reducing the amount of Medical Expense Deductions - Thereby
lowering your chances of being pushed into AMT
- Reducing reportable income - Thereby reducing the amount of income
subject to AMT calculations.
Example - A family putting $7,000 into
a Flexible Spending Account would expose
$7,000 less in income to the Alternative Minimum Tax - thus generating up to
$1,820 in tax savings.
4- Child Tax Credit Savings
This credit is worth up to $1,000 annually per qualifying child.
However, the credit is phased out beginning at specified levels of Adjusted Gross Income for each filing status:
- $110,000 - Jointly
- $75,000 - Single, or Head of Household
- $55,000 - Married filing Separatley
Your Child Tax Credit is limited by 5% for each dollar of Adjusted Gross Income above these amounts.
Example - For a family putting $7,000 into
a Flexible Spending Account, the Child Tax Credit limitation might minimized by $350.
5 - Education Tax Credit Savings
The amount of an education credit is determined by the amount of
qualified tuition and related expenses you paid for each eligible
student and the amount of your Modified Adjusted Gross Income (MAGI).
The credit is worth up to $2,000 annually, and is phased out between
$90,000 and $110,000 of MAGI. A Flexible Spending Account could
generate tax savings if your MAGI fell between these two figures.
Example - A family putting $7,000 into
a Flexible Spending Account might reduce the amount of Education Tax Credit phase out by 7/20 or 35% equating to $700 of tax savings.
6 - State Income Tax Savings
Tax rules, rates, and possible tax savings
vary by state. The States of NJ & PA do not recognize Dependent
Care FSA pre-tax deductions. NJ does not recognize Healthcare FSA
pre-tax deductions.
Example - A family putting $7,000 into
a Flexible Spending Account and in the 6% State Income Tax bracket might realize State Income Tax savings of $420.
Which is Better - FSA or Child Care Tax Credit
Follow the page links below for further details on the four key factors: eligible child care expenses, number of children, and your federal income tax bracket.
