The contributions you make to a flexible spending account (FSA) are not tax-deductible because the accounts are funded through salary deferrals. However, contributing to an FSA does reduce your taxable wages since the account is funded with pretax dollars.
The maximum amount of salary deferral in an FSA for the 2022 tax year is $2,850, rising to $3,050 in 2023. (In previous years, the maximum has been increased by $50 per year).
- An FSA helps employees cover health-related costs not included in their insurance plans.
- Contributing to an FSA reduces taxable wages since the account is funded with pretax dollars.
- Since your FSA contribution is paid in pretax dollars, it cannot be taken as a tax deduction.
- You may be able to use the FSA to help pay for things like a gym membership or massage therapy, with a doctor's prescription.
What Is an FSA?
An FSA (flexible spending account or flexible spending arrangement) is a savings account that helps employees cover health-related costs that are not included in their insurance plans.
The specifics vary, but such plans generally can be used for expenses like deductibles and co-payments, or for health-related items like prescription glasses. Some can be used for alternative treatments like acupuncture. With a doctor's prescription, you may be able to use the FSA to help pay for a gym membership or massage therapy.
First aid products are generally covered, including items like bandages. Many over-the-counter medications and remedies are covered, but only if you have a doctor's prescription for them. These include common products like:
- Cold medicine
- Acne cream
- Ear wax removers
- Wart removers
Someone at the IRS presumably made lists of which common household items are health products and which are merely healthful products. Vitamins and herbal remedies are not covered, nor is plastic surgery or teeth whitening.
How an FSA Lowers Your Taxes
Just like a 401(k) retirement plan, an FSA account is funded through deductions taken directly out of your paycheck. When you have an FSA, you are setting aside part of your salary so that you will be reimbursed for eligible medical or dependent care expenses during the year instead of paying out-of-pocket. You cannot claim a tax deduction for your contributions because the money was not taxed in the first place.
You decide once a year, during your benefits enrollment period, what percentage or amount of your salary you would like to defer into the FSA, up to a maximum. The money deferred is considered being paid with pretax dollars. So it reduces your gross income, which lowers the tax bill you will pay.
For example, if your annual salary is $40,000 and you decide to contribute $2,000 to your FSA, your gross income would then be $38,000. Any federal, state, or local taxes you pay would be based on that amount.
An FSA account holder cannot use it to fund purchases of common household items like toothpaste or shaving cream.
Don't Over-Fund Your FSA
One word of caution: avoid over-funding your FSA account. Any balance remaining in the account is commonly forfeited at the end of the year, although some plans have a grace period to submit claims into the next tax year or allow some remaining money to be rolled over. In 2023, your plan may allow you to carryover up to $610. Whether these options are available, however, depends on the specifics of the plan your employer chose.
At the very least, keep an eye on the balance in your FSA and make sure you use it by the annual deadline. If the annual deadline is approaching, you can hit the pharmacy aisle and get some of the many over-the-counter remedies and products that an FSA covers. But don't go overboard. The regulations specifically prohibit stockpiling products that can't reasonably be used up in the year.
What Is the Tax Advantage of FSA Contributions?
Since contributions to the account are deducted from your paycheck before income taxes are assessed, your taxable income is lower. Participants enjoy, on average, a 30% tax savings on the total amount they contribute to the account.
Can I Still Deduct Dependent Care Expenses?
Yes, but not the same expenses for which you have already been reimbursed. If your total expenses were $7,000 and you were reimbursed $5,000 from your DCA, you may only claim the $2,000 difference.
The Bottom Line
Contributing to an FSA allows you to reduce your taxable income as well as save on healthcare or dependent care costs since you are paying for these expenses in pretax dollars. In other words, you're saving about 30% on an expense, whether it's laser eye surgery or sunblock (as long as it's more than a specific SPF).
Using an FSA efficiently requires accurate forecasting. While you can't predict everything you'll need, you are likely to be able to plan a visit to the dentist, some over-the-counter medications, or a vision correction prescription. Depending on your situation, using the account to fund some of those expenses earlier in the year can prevent rushing to spend down the account as the year draws to a close.
The information contained in this article is not tax or legal advice and is not a substitute for such advice. State and federal laws change frequently, and the information in this article may not reflect your own state’s laws or the most recent changes to the law. For current tax or legal advice, please consult with an accountant or an attorney.