Flexible Spending Accounts (or FSAs) are an often-overlooked benefit that you can offer your employees. FSAs come under section 125 of the Internal Revenue Code and allow your employees to convert some of their taxable pay into nontaxable benefits.
Healthcare FSAs enable employees to set aside money from each paycheck before the deduction of taxes. Employees can then use this money to pay for qualified out-of-pocket medical expenses. These include deductibles, copayments, prescription medications, dental care, and vision.
Dependent Care FSAs are a pre-tax benefit account used to pay for eligible dependent care services. These include childcare, elder care, after-school programs, and summer day camps.
Parking and transit FSAs allow employees to use these pre-tax dollars to pay for commuter and parking expenses incurred while traveling to and from work. This may include parking garage fees near your place of employment or mass transit (train, subway, bus) fees.
FSAs benefit everyone as they offer flexibility for employees to spend on medical, dependent care, or commuting expenses that suits their individual needs while allowing you and your employees to save on taxes.
So, let’s delve deeper into these benefits.
How employees benefit from Flexible Spending Accounts
Increases spending power
Employees avoid paying taxes on FSA dollars as they are put into accounts before taxed.
Since employee contributions to their FSAs are excluded from gross income, they are not subject to income taxes or payroll taxes (Social Security and Medicare), reducing the amount of tax they have to pay. For example, if one of your employees earns $50,000 for 2021, is in the 22% tax bracket, and contributes $3,000 to their FSA, they’ll save $660 ($3,000 x 0.22) in income taxes.
The same goes for payroll taxes. In 2021, your employees must pay 6.2% of Social Security taxes on the first $142,800 they earn. In addition, all earnings are subject to 1.45% of Medicare taxes. So, using the same example again, an employee earning $50,000 and contributing $3,000 to an FSA will save $229.50 ($3,000 x 0.062 + $3,000 x 0.0145) in payroll taxes.
Immediate access to funds
Another major advantage is that the amount that an employee pledges to pay into their Health FSA is available for immediate use. For example, an employee pledges to contribute $2,000 to their Health FSA. They begin monthly contributions of $200 on January 1st, 2022, and incur $2,000 in uninsured qualified vision care expenses on January 23rd. They can use their pledged FSA to pay the total amount even though they have only contributed $200 to date.
How employers benefit from FSAs
Low costs and fees
While you can administer your own FSA program, it’s a complex process that involves filling in numerous forms and keeping up with changing legislation. That’s why it’s worth letting a third-party organization do the administration for you.
As an employer, you also avoid the payroll tax (Social Security and Medicare) on the amounts that your employees contribute to their FSAs. For example, if one employee makes a contribution of $1,500 to a Healthcare FSA, and another contributes $4,500 to a Dependent Care FSA, you can gain the following tax savings:
- Healthcare FSA tax savings: $1,500 x 0.0765 = $114.75
- Dependent Care FSA tax savings: $4,500 x 0.0765 = $344.25
While this may not seem like a considerable amount, it can certainly add up.
Unused FSA funds return to the employer
Employers receive any funds above the carry over allotment left unused by employees at the end of the plan year. You can then use these funds to cover administrative costs and other losses or distribute them to employees who sign up for an FSA in the next year.
Other things employers should know about FSAs
The ‘use it or lose it’ rule may put off employees. It would help if you encouraged them to use all of their FSA funds with end-of-year reminders or offer a grace period during which they can use the funds.
Another thing to be aware of is the flip side of the ‘immediate access to funds’ for employees. Employers are stuck with the difference if an employee pledges FSA dollars and uses them before paying into the account and then leaves the organization. There is no way to collect the money owed. While this may happen rarely, it should be recognized.
Offering Flexible Spending Accounts is a win-win. By providing such benefits, you’re allowing employees the freedom to spend on solutions that suit their circumstances while lowering the tax they (and you) pay.
Contact Tandem HR today for more information on offering FSAs to your employees.