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Flexible spending account not subject to FICA

Dear Tax Talk,
My employer takes a child-care flexible spending account deduction of $5,000 per year from my gross pay. Does this deduction affect my Social Security earnings, or is this deduction viewed the same as a 401(k) deduction? Will my gross pay still be the amount of earnings for Social Security? -- Jerry

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Dear Jerry,
Under an employer-sponsored flexible spending arrangement, your employer is reducing your salary by the amount that you elect to defer to pay for certain eligible fringe benefits. Provided you use the funds as intended, they are permanently excluded from your income.

One of the eligible fringe benefits is dependent-care expenses, or amounts that you use to pay for the care of your children (or other eligible dependents) while you work. The chart on page 4 of Publication 15B, Employer's Guide to Fringe Benefits, lists various benefits and their treatment for payroll tax withholding.

Dependent-care assistance of up to $5,000 annually would be exempt from all federal payroll taxes, hence your Social Security wages will be that much lower than your gross pay for the year.

Retirement contributions are treated differently because they defer pay, whereas the dependent-care assistance benefit permanently excludes the payment from income. Therefore your 401(k) contributions are taxable for Social Security and Medicare. If you do not use the full $5,000 for dependent-care assistance, you would include the unused amount as additional compensation but would not have to pay Social Security or Medicare taxes on that amount.

Bankrate.com's corrections policy
-- Posted: Sept. 2, 2005
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