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Deductibility of flexible spending account

Dear Tax Talk,
I have a flexible spending account. I realize the funds are not taxed, but what, if anything, can I declare as deductible on my federal tax return from the amounts I spent? I was actually reimbursing myself. Thank you.
-- MJ

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Dear MJ,
A health flexible spending arrangement, or FSA, allows employees to be reimbursed for qualified medical expenses on a pretax basis. This means that the amount that you elect to defer into an FSA is not included as wages on your Form W-2. Literally, an FSA is a savings account for medical expenses that will not be paid for by insurance.

For example, an FSA can pay for eyeglasses, co-pays, over-the-counter drugs (such as antacids, aspirin, cold formulas, etc., but not vitamins) dental work, psychotherapy and other items that have limited or no reimbursement under an insurance plan. FSAs are usually funded through voluntary salary reduction agreements with your employer. This means that if you anticipate spending $2,000 a year in noncovered medical expenses, you would ask your employer to defer $2,000 of your salary to an FSA to pay for these items as they are incurred. No employment or federal income taxes are deducted from your contribution. For example, on a $2,000 deferral, you can end up saving $500 or more in taxes, depending on your tax bracket. The employer may also contribute some funds to your FSA.

Eligible medical expenses are described in Publication 502. Since these items are paid for on a pretax basis, you would not be eligible to deduct them again as an itemized deduction of medical expenses. Of course, any amounts in excess of those reimbursed by the FSA could be deductible. However, it would make more sense to increase your FSA deferral, since there would be a greater tax advantage.

For example, as an itemized deduction you would have to pay tax on the first 7.5 percent of your unreimbursed medical expenses, whereas under the FSA all the medical expenditures are tax-free.

Unfortunately, though, you can only change your FSA deferral at the beginning of the FSA's plan year. For example, if the beginning of the FSA's plan year is Jan. 1, you need to estimate then how much you'll need to defer to pay for noncovered items. If you exhaust the account in June, you cannot increase your contributions. You have to wait until the following year to increase your deferral. Conversely, if you contribute too much and do not have enough eligible expenses, you may have to forfeit the balance in your account.

Last May the IRS relaxed this use-it-or-lose-it rule by extending the time by which plan participants can make claims against their accounts for two and a half months beyond the end of the plan year. Your employer has to be onboard with this ruling, so check with your benefits department to learn the particulars about your plan.

Bankrate.com's corrections policy-- Posted: Nov. 23, 2005
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