A flexible spending account (FSA) is a tax-advantaged account offered by an employer so that employees can set aside part of their earnings to pay for qualified expenses. Monies deducted from employee earnings into an FSA account are not subject to payroll taxes, which results in savings for the employee. The most common expenses in these cafeteria-type benefit plans are medical and dependent care expenses.
Cafeteria plans, as defined in Section 125 of the Internal Revenue Code, are benefit programs that allow employees to select benefits from a "menu" of offerings. If a business offers an FSA with medical and dependent care options, employees can put money into each plan, but cannot switch monies from one plan to another.
Employer Benefits of a Flexible Spending Account
Businesses find that offering employees FSA accounts benefits them since the employer does not have to pay Social Security tax on the employer portions of the benefits. This can save a business 7.65 percent of payroll taxes for the employee which is significant, especially to a small business. The more the employees contribute to the FSA, the greater the business savings, as the amount contributed by the employee reduces the employer tax responsibility. This saving is often the deciding factor on whether offering a benefits package to employees is feasible.
Employee Benefits of a Flexible Spending Account
Employees selecting benefits from an FSA make contributions from pre-tax dollars. This equates to savings to the employee since they save federal and state income taxes on the amount contributed, as well as Social Security taxes. The employee authorizes the employer to withdraw the money to place in the FSA accounts from their payroll checks. If the employee reduces the amount of their taxable income they can maximize the amount of money they actually take home.
The amount of money that the employee has deducted pre-tax from their paychecks for FSA-qualified benefits must be used in the calendar year of the withholdings, or else it is forfeited. Therefore, employees must evaluate anticipated expenses for dependent care or medical expenses so that the amount of monies put into the FSA accounts is not too little or too much.
Medical FSAs are popular, as they allow the employee to determine how they wish to spend the money in the account. It can be used to pay for health care copayments or deductibles, vision or dental services, prescriptions or ancillary services. Dependent care expenses can be allocated to childcare payments or adult long-term care expenses.