Flexible Spending Account (FSA)

At a Glance
When the tax laws changed during the 1980s, businesses became eligible to set up flexible spending accounts (FSAs) for employees, who could use them to pay for medical expenses or child care. Employees are not liable for income taxes and businesses are not liable for payroll taxes on those funds, which employees arrange to have deducted from their paychecks.

The net result is positive to both the business and the employee. The business realizes a reduction in the tax liability, while the employees are able to pay for certain expenses (generally medical and child care expenses) on a pre-tax basis.

How does it work?
To participate in the FSA program, the employee decides each year how much money to allocate to their spending account(s). For example, an employee may elect to contribute $2,000 to the healthcare spending account and $1,000 to their dependent child care spending account. The employee’s salary is reduced by this amount (hence, the employee tax savings), and the cash is paid back to the employee as they incur these expenses throughout the year.

The FSA regulations include a ‘use it or lose it’ provision. This means that the employee forfeits any money left in the account at the end of the year. This makes it critical for each employee to accurately estimate the amount to contribute to their spending accounts each year.

Do I need it?
FSAs are one of the most popular employee benefits today. According to a study conducted by William M. Mercer, Inc., and Bright Horizons Family Solutions, 85 percent of employers offered health care FSAs in 2000, and 82 percent offered dependent-care accounts.

Beyond their popularity with employees because of the tax savings they provide, they are generally cost effective for employers as well. In short, your company will realize a reduction in taxes that are associated with your total payroll expense. For example, your total FICA responsibility will be reduced, as well as your total Workers Compensation expense.

How do I buy it?
There are a great number of sources to provide FSAs, but you may have to look no farther than your existing insurance or benefits package. Check with your representative or insurance broker to see whether such a service is available and if it meets your needs and budget. If you are securing these services for the first time, you should inquire if they can be included in a benefits package or business insurance.

Because there are federal regulations at play, and fines for noncompliance, experts recommend that you should have a professional handle the program’s administration and not attempt to do it yourself.