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In an effort to provide cost-saving programs to their employees, many companies today offer a tax saving vehicle called the flexible spending accounts ("FSA"). Through FSAs you can pay for certain non-reimbursable medical costs and some child care costs with PRETAX dollars. FSAs work like this: You elect to put "X" amount of dollars in your FSA account (varies with your company's individual program), the amount gets deducted from your paycheck in equal installments BEFORE taxes. When you actual incur the medical or daycare cost, you fill out a claim for reimbursement. Because the FSA elected amount is drawn out of your paycheck pretax, your taxable income is reduced by an equivalent amount. Lower taxable income results in lower tax liability. Therefore, if you participate in an FSA program and spend $1,000 on medical or daycare and your tax rate is 30%, you will save about $300 in taxes, which in effect is a $300 savings on your medical or daycare bills. Sign Me Up! Unfortunately, saving tax dollars is not without strings attached. If you don't use all the money in your FSA account, You Lose It! Yes, I said: "Lose It." For example, if you elect to put $3,000 in an FSA account and you only have $1,000 of valid charges at the end of the year, you will never ever see the $2,000 left in your account. It will vanish into the FSA black hole, never to be seen again. So before signing up for an FSA, carefully calculate your projected non-reimburable costs, keeping in mind that what you don't use, you lose.
Another catch that affects daycare FSA programs is you can't use it if you claim the child care credit on your tax return. So if you already claim a child care credit on you taxes, work with your tax advisor to calculate the method that will yield you the best savings. As with all tax related situations, it is best to check with your professional tax advisor before trying anything new.
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