Do you have high medical bills or dependent care expenses? You may be able to save hundreds of dollars each year by participating in Flexible Spending Accounts, according to the Society of Louisiana CPAs.

A health care flexible spending account is an employer-sponsored benefit that allows you to set aside a predetermined amount of money from each paycheck for eligible medical and dental expenses. If you pay someone to care for a dependent, you also can establish a dependent care FSA. In addition, some employers allow you to use a similar method for mass transit and parking expenses necessitated by your job.

An FSA saves money by reducing income and Social Security taxes. That is because the money you choose to contribute to your FSA is deducted from your paycheck before taxes. The salary reduction contributions are therefore not included in your W-2 as taxable wages.

How FSAs Work

Once a year, typically in the fall, employers hold an open enrollment period for FSAs. If you decide to participate, you will need to determine in advance how much money you want deducted from your paycheck and deposited into your FSA during 2003.

The amount you select is deducted in equal installments from each paycheck and set aside in an account. Upon submission of proper documentation verifying the expense, you are reimbursed from your FSA. This is true even if the amount exceeds your contribution to date. For example, if you designate $2,400 for the year, and have $2,000 in expenses the first month, your employer must reimburse the full amount, even though only $200 has been credited to your FSA.

By law, the maximum amount of salary you can contribute to a dependent-care FSA is $5,000. There is no legal limit on health care FSA contributions, but most companies establish their own limits.

Calculating Your Health Care FSA Contribution

To estimate how much you should set aside in a health care FSA for 2003, add up the anticipated costs for routine medical and dental checkups and major expenses, such as braces, for you and your family members. Any expense the IRS considers deductible that is not paid through your health insurance is eligible for reimbursement.

Most employers provide a list of reimbursable expenses. Some of the more common reimbursable expenses are annual deductibles, co-payments, contact lenses and glasses, hearing aids, and prescription drugs. Expense not recognized by the IRS – and, therefore, not reimbursable – include the cost of cosmetic surgery, nonprescription drugs, and health club dues for general health purposes.

Establishing a Dependent Care FSA

Eligible expenses for dependent care reimbursement include the cost of care for a child under 13 who qualifies as your tax dependent. You also can claim a person of any age who cannot care for him/herself because of physical or mental inability.

With a dependent care FSA, you pay expenses as you normally would, then submit proof of payment to be reimbursed from your account. The maximum tax-free reimbursement is $5,000. Keep in mind that any FSA reimbursement reduces the amount you can use to create a dependent care credit. That credit decreases your taxes dollar for dollar and is based on expenses used to care for a qualified dependent while you are gainfully employed.

Use It or Lose It

You will want to estimate your FSA expenses as accurately as possible. If there is a balance left in your account at the end of the year, you forfeit it. (You may request reimbursement for expenses incurred during the year within a specified period after year-end without forfeit.) Current federal law does not permit employers to refund money or carry it over to the next year. What is more, you are not allowed to adjust the amount or drop out of the plan unless you experience a change in family status such as a divorce or the birth of a child.

Added Benefit of FSAs

FSAs provide another way to save tax dollars, particularly for middle and upper-middle income workers. The eligibility requirements for many of the tax breaks in the 2001 Tax Act are based on adjusted gross income. Sheltering tax dollars can lower your AGI and enable you to qualify for additional tax breaks.