It may be helpful to follow a Flexible Spending Account tax savings example. Most FSA eligible expenses can be tax deducted on Schedule A at the end of the tax year. Plus, the amounts contributed to an FSA can be lost if not used. Why bother?
What you will find is that an FSA is best for predictable expenses; recurring medical needs that accumulate ongoing expenses. Unlock the maximum value by breaking down this Flexible Spending Account tax savings example compared to Schedule A deductions.
- Bigger percentage savings
- First dollar savings
- Reductions in W2 Income
Primary FSA Tax Savings Examples
Why make FSA contributions that you might lose when the same expenses can be tax deducted each April? This question is one of the biggest stumbling blocks preventing families from fully leveraging Flexible Spending Account benefits for families. There are three significant FSA tax savings examples that many families might otherwise miss: bigger FICA savings, first dollar savings, and reductions in reported income.
FICA Payroll Tax Savings Example
The first Flexible Spending Account tax savings example to explore pertains to FICA taxes. 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.
The Social Security tax is 6.20% which is applied to a maximum earnings limit of $114,000 in 2014. Each year the maximum earnings limit rises. The Medicare tax rate is 1.45% and has no maximum limit. Both the employee and employer pay the same amount of payroll tax (FICA Tax). For most employees the total payroll tax rate is 15.3%
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
- $0 in payroll tax savings by using Schedule A deductions
First Dollar Tax Savings Example
The second Flexible Spending Account tax savings example to explore is first dollar tax savings compared to taking deductions on Schedule A. Many families simply don’t generate enough qualified expenses to see any tax savings using Schedule A. The higher your income, the higher will be the deductible limit threshold.
The IRS limits your qualified medical and dental expense deductions to those over 10% of your Adjusted Gross Income (AGI). The recently enacted Patient Protection and Affordable Care Act raised the beginning in 2014 as a means to generate extra revenues to pay for the bill. These same expenses are often FSA eligible expenses also.
Example – A couple with an AGI of $100,000 gets no tax savings on the first $10,000 of medical deductions. The same couple making maximum healthcare FSA contributions at both employers will see first dollar tax savings on the first $5,000 of eligible expenses.
|FSA Savings||Schedule A Savings|
|Federal Income Tax – 25%||$1,250||$0|
|FICA Tax – 7.65%||$383||$0|
|State Income Tax – 5%||$250||$0|
Secondary FSA Tax Savings Example
The third Flexible Spending Account tax savings example to explore is the reduction in reportable w2 income and the impact on downstream taxes. Making pretax contributions into an FSA reduces the amount of reported w2 income. Some tax rules have phase-in and phase-out rules that are based upon the amount of reported income.
Example: Two couples have the same gross income of $100,000. One couple makes no FSA contribution. The other makes maximum FSA contributions at both employers for healthcare, dependent care, and commuter accounts.
|Couple 1||Couple 2|
|Dependent Care FSA||$0||$5,000|
|Transit and Vanpooling FSA||$0||$1,584|
|Reported W2 Income||$100,000||$85,416|
Now consider four downstream tax rules that may be impacted by the reduction in reported w2 income.
Alternative Minimum Tax Savings
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. Also if subject to the AMT the amount of income taxed at the higher rate is reduced by a smaller reported w2 income.
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.
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 separately
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 be minimized by $350.
Education Credit Tax 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.
- FICA Limits SSA.gov
- Transit contribution limits Core Documents
- Downstream tax savings – Form 1040 instructions
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