USE YOUR DEPENDENT CARE FSA TO PAY FOR SUMMER CAMP

Do you participate in your employer’s Dependent Care Flexible Spending Account?  And will your under age 13 child be attending summer day camp?

You may be able to have the cost of the summer day camp paid by your Dependent Care FSA.

Participants in an employer-sponsored dependent care FSA set aside a specific dollar amount from their salary to pay for qualified child-care during the year. The maximum amount you can set aside for a dependent care plan is $5,000.

Monies set aside in a Flexible Spending Account are considered “pre-tax” for both federal income tax and FICA (Social Security and Medicare) tax purposes. If your annual salary is $50,000 and you set aside, and spend, $5,000 in an FSA, the federal wages reported in Box 1 on your Form W-2, as well as the Social Security and Medicare wages, will be $45,000. If you are in the 25% bracket, this $5,000 will save you $1,633 in federal income and FICA taxes.  So about 33% of the cost of child care paid via this account is “reimbursed” by your Uncle Sam.

If you state also treats Dependent Care FSA contributions as “pre-tax” your overall tax savings will be even greater.  FYI New Jersey does not treat FSA contributions as “pre-tax” on the NJ-1040.  The NJ state wages reported on a Form W-2 will not be reduced by your FSA contributions.

A Dependent Care FSA is a “use it or lose it” plan.  If you set aside $5,000 in the DCFSA, but spend only $4,000 on qualified expenses during the year, you lose $1,000!

If you do not use money from your FSA to pay for summer day camp you can claim a Credit for Child and Dependent Care Expenses of up to $3,000 if you have one child or up to $6,000 if you have two or more qualifying children.

In many cases the FSA provides a greater tax savings than the tax credit.  For most cases the credit is 20% (it can be higher for lower-income taxpayers) - so the maximum credit is usually $600 for one child or $1,200 for more than one.  As stated above, the maximum tax savings from a Dependent Care Flexible Spending Account could be $1,633.  Do the math and calculate your potential tax savings under each option before deciding what to do.

In either case be sure to get the Employer Identification Number of the summer camp.  You will need to enter this number, along with the name and address of the camp, on IRS Form 2441.  

Special rules apply if you are filing your tax return as Married Filing Separately.  MFS filers are limited to a $2,500 exclusion from taxable wages instead of $5,000 on the Form 1040.  And couples filing separately may not be able to claim a tax credit for child care expenses.   

TTFN

FLEXIBLE SPENDING ACCOUNT

Many employers offer their employees the opportunity to participate in a “Flexible Spending Account” (FSA).  If your employer offers an FSA you should consider enrolling – you can realize substantial tax savings from such a plan.

For many employers fall is “open enrollment” for FSAs.

Participants in an employer-sponsored dependent care or health care FSA can set aside a specific dollar amount from their salary each year to pay for qualified child-care or medical expenses during the year. The maximum amount you can set aside for a dependent care plan is $5,000. There is no statutory maximum for a medical expense FSA, but most employers will impose a limit.

Monies set aside in a Flexible Spending Account are considered “pre-tax” for both federal income tax and FICA (Social Security and Medicare) tax purposes. If your annual salary is $50,000 and you set aside, and spend, $5,000 in an FSA, the federal wages reported in Box 1 on your Form W-2, as well as the Social Security and Medicare wages, will be $45,000. If you are in the 25% bracket, this $5,000 will save you $1,533 in federal income and FICA taxes.

A pre-tax contribution to a dependent care FSA will generally provide a greater tax benefit than claiming the Child and Dependent Care Credit – especially for those in the 25% and higher brackets. The maximum credit allowed is $600 for one qualifying child or $1,200 for more than one qualifying child.

Medical expenses are deductible as an Itemized Deduction on Schedule A only to the extent that they exceed 7 1/2% of your AGI. Medical expenses paid through a pre-tax health care FSA are fully deductible from gross income.

The savings does not end there. Employee contributions to an FSA will reduce Adjusted Gross Income and could increase a multitude of deductions and credits affected by AGI.   Plus many states also treat FSA contributions as “pre-tax”, so you may save state income tax as well. 

An FSA is a “use it or lose it” plan. If the amount of qualifying child-care or medical expenses paid by an employee-participant during the year is less than the amount that has been set aside in the plan the employee loses the excess.

if Mary Mom has set aside $5,000 of her salary in her employer’s dependent care FSA for 2011, but pays only $4,000 in qualifying child care expenses during the year, she loses $1,000 in wages! The $1,000 cannot be carried forward to the next plan year. So if you are a participant in a dependent care FSA and you currently have an unspent balance in your “account” make sure you spend that balance before year-end so you do not have to forfeit any of your salary.

There is an exception for a medical expense FSA. If the plan allows, participating employees have until March 15th of the next to submit expenses to the plan. If the above example was for a medical FSA Mary would have until March 15, 2012 to submit up to $1,000.00 of medical expenses to apply against the $5,000 set aside for 2011.

TTFN

ASK THE TAX PRO - UNUSED FLEXIBLE SPENDING ACCOUNT CONTRIBUTIONS

Q. What happens to money left behind in the FSA? I lost track of time and left $1000 behind in my FSA account. Ok, so I lose and it's a forfeit. Any chance I can deduct the monies left behind?

A. You cannot claim a “loss” or miscellaneous itemized deduction for unused, or forfeited, FSA monies.

The monies you contributed to your FSA, including the $1,000 that was forfeited, have already been deducted on your tax return. The total amount of wages that are paid into a Flexible Spending Account reduces the taxable federal wages reported in Box 1 of your Form W-2.

If you contributed $5,000 of your wages to the FSA then your “take home pay” and your federal taxable wages (and possibly state taxable wages) are reduced by $5,000. If your gross wages are $100,000 the W-2 will show $95,000. If you only submitted $4,000 in expenses then you have indeed suffered an economic loss of $1,000 – but it is income that was not taxed.

All is not lost. Under the new rules for Flexible Spending Accounts you have until March 15th of 2009 to submit expenses against FSA monies contributed for tax year 2008 – if your plan so permits. This applies to both medical expense and dependent care FSAs.

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So there is still time to use the $1,000 balance in your 2008 account!

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TTFN

ASK THE TAX PRO - MEDICAL FSA + INCOME TAX WITHHOLDING

Since my tax-season “hiatus” from blogging is fast approaching, I will be doubling up on ASK THE TAX PRO Wednesdays, and possibly adding extra days, to be sure I answer all the appropriate questions that have accumulated. Please do not submit any more questions now until mid-April.

Q. I am having a problem with the way my company pays my commission and I'm wondering if I can tell them it’s illegal. I work in advertising sales for a relatively small company. We get commission on sales plus a base salary. Since the company refuses to cut checks for less than $1,000, if a commission check is less than $1,000 net they just lump the commission money into our base salary paycheck.

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I have pointed out to them that by doing so I get taxed more on the commission than I would if they just cut me a check for the commission only.

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Here's the breaking point: Recently they miscalculated my commission by about 50% therefore making the check less than 1,000 so they lumped the commission into my salary check. I told them about their mistake and they said they would put the remaining commission on my next paycheck (again with the higher tax rate).

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Can they keep doing this? I didn't think commission was allowed to just be rolled onto a salary paycheck as it messes up my tax bracket. Any advice you have is greatly appreciated as I would like to make a knowledgeable demand here.

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A. You seem to be confusing tax withholding with tax liability.

You are not being taxed any differently on straight commission checks than you are on your “draw”. Both amounts are combined on your Form W-2. You pay tax on the total combined amount based on your particular federal and state tax brackets, determined after deductions and exemptions.

The FICA (Social Security and Medicare) tax is withheld at the same rate on a straight commission check, a straight base pay check, or a “combination” check – 7.65%. Any state unemployment and disability contributions are also withheld at the same rate from any payroll check. However, this type of withholding usually has a relatively low income threshold and you will have the maximum withheld during the first half of the year.

Where you see a difference is in the federal and state income tax withholding.

The amount of federal and state income tax withheld as a percentage of gross pay is based on tables published by the Internal Revenue Service and your individual state, your withholding status, and the number of exemptions you claimed on the Form W-4 you provided to your employer.

The problem arises when the amount of your check varies from pay period to pay period, as it would if commissions are added to base pay on a sporadic basis. The tax tables are based on the concept that you will receive the same amount of gross pay each pay period, and calculate withholdings accordingly.

Here’s a simplified example. If your base pay is, say, $500 per week the tables will assume that your gross income for the year is $500 x 52 or $26,000. If you claimed “Single-1” on your Form W-4 the tables will basically determine the annual tax liability for a single individual with $26,000 in income who is claiming one exemption for himself/herself and divide that amount by 52. This is the amount of income tax that is withheld.

If your employer includes $800 in commissions in with the normal $500 base pay one week, the tables will assume your gross income for the year is $67,600 ($1,300 x 52) and determine the amount of income tax to withhold accordingly. Because this calculation would push the assumed annual income into a higher tax bracket, a higher percentage of the income is withheld.

Your employer is doing nothing illegal or even wrong. Click here to see the IRS instructions for payments of “supplemental” income such as commissions. And you have not lost this money. The additional amount of federal and state income tax withheld on “combined” checks will either result in an increased refund or a reduced tax due when you file your tax returns next month.

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If you feel that you are having too much federal and/or state income tax withheld you can always submit a new Form W-4 to your employer so that you have less tax withheld. The greater the number of exemptions you claim the less you will have withheld.

You can go to www.paycheckcity.com and use their paycheck calculators to see how a change in withholding exemptions will affect your take home pay.


Q. I have always used a Flexible Spending Account and been proud to say that I have never left any money "trapped" in the account at year end and have been good about estimating my costs each year to maximize the benefit. This year, I know that I will have a large medical expense, about $11K. So, when filling out the forms for 2008 benefits last month, I opted for the maximum $5000 FSA contribution, again, very proud of myself.

Then, last week, a friend of mine who recently had a large medical expense made the comment, "well, at least it was fully deductible." I read up, and lo and behold the $11K should be deductible, because it would be more than the 7.5% of my AGI. But, I was looking on the IRS's web site, and as far as I can tell, I may have actually shot myself in the foot here, since it seems I can't include the full $11K in calculating the 7.5%, only the $6K NOT in the FSA. Is that correct? $6K alone is not enough to meet the 7.5% test for me. If that is the case, it seems I am actually being penalized for having the FSA? I feel pretty stupid now, but no one has ever raised the idea to me that taking out an FSA would not be the best option in some cases. Any thoughts or advice?

I plan to call my benefits group to see if I can reverse the election, but they usually do not make changes. If this is true, I really feel that there should be a caveat about needing to make sure it's right for you if you have high medical expenses in all the benefit literature. I have been trying to research this online, and all I find is advice about how great these accounts are. Hopefully, I am wrong about this!

A. Don’t feel stupid. In your situation the $5,000 medical Flexible Spending Account (FSA) contribution was indeed your best option. Do not, I repeat, do not reverse your election!

Contributions to a medical FSA automatically reduce your federal taxable wages, your FICA (Social Security and Medicare) wages, and possibly your state taxable wages. If your gross wages are $90,000 and you contribute $5,000 to a medical FSA you are only paying tax on $85,000. Click here to view the appropriate IRS publication.

In addition your Adjusted Gross Income (AGI) is reduced by $5,000, which could increase a variety of deductions and credits and also reduce exclusions that are affected by AGI. See my posting on “The Most Important Number on Your Tax Return”.

By contributing $5,000 to your medical FSA you have received a $5,000 “above-the-line” tax deduction for your medical expenses. An "above the line" deduction is always better than a "below the line" (i.e. itemized) deduction.

Let’s say your gross wages are $90,000, FSA contributions are “pre-tax” for state income tax purposes, you are in the 25% federal and 5% state tax bracket, and you have no other taxable income. The $5,000 contribution to the FSA would save you 37.65% in total taxes (25% federal, 5% state and 7.65% FICA) or $1,883. You would not be able to deduct any of the remaining $6,000 in medical expenses because 7½% of your $85,000 AGI is more than $6,000.

If you did not made the $5,000 FSA contribution your AGI would be $90,000. You would be able to deduct $4,250 in medical expenses on Schedule A ($11,000 less $90,000 x 7.5%). At most you would save $1,275.00 in combined federal and state income taxes ($4,250 x 30%).

In the above example by contributing the $5,000 to your medical FSA you saved over $600 in taxes!

As you had indicated, medical expenses not paid or reimbursed through a medical FSA can be claimed as an itemized deduction on Schedule A, subject to the 7½% of AGI exclusion. You stated that the $6,000 remaining expenses in your situation would not exceed the exclusion. Be sure you include all your allowable medical expenses. My special report DEDUCTING MEDICAL EXPENSES ON YOUR 2007 FORM 1040 provides a detailed listing of all allowable expenses. Click here for more information.

TTFN