 Deductibility
of flexible spending account
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 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
 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.
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