Flexible Spending Arrangements...

Are high medical costs getting you down? You can use a federal tax-sanctioned plan that enables your employees to pay medical costs not covered by insurance on a pre-tax basis. See whether a flexible spending arrangement (FSA) can work for you.

How an FSA works
Even if you pay or share the cost of medical insurance for employees, not everything is covered. Annually, you and your employee may face thousands of dollars in out-of-pocket expenses. Your company can set up an FSA that allows employees to contribute a portion of compensation to the plan on a pre-tax basis (called a “salary reduction”).

Example: An employee earning $30,000 agrees to contribute $200 each month ($2,400 for the year) to an FSA. For federal income tax purposes, only $27,600 of the compensation is taxable to the employee. Employee contributions to FSAs are also exempt from state and local income taxes (except in New Jersey and Pennsylvania).

Important: FSA contributions are exempt from Social Security and Medicare (FICA) taxes, saving both the employee and the company money.

Setting up the plan. Technically, an FSA is part of a “cafeteria plan.” This is a benefit plan in which you offer employees a choice between taxable and nontaxable benefits. If employees opt for nontaxable benefits (e.g., health coverage), they are not taxed.

The plan works best for C corporations because owners of other entities cannot participate.

Reimbursement. Employees can obtain reimbursement from their accounts up to the amount they contribute annually. This includes out-of-pocket medical costs that would be deductible as an itemized deduction, such as vision and dental care, as over-the-counter medications (e.g., cold remedies, pain relievers and allergy medications).

To obtain reimbursement employees must submit proof of having paid a covered medical expense. If your company is small (under 20 or so employees), you can administer the plan in-house. Designate someone to review reimbursement submissions. But if your company has a large number of employees in the FSA, it may be better to have an outside company administer the plan on your behalf. There are a number of companies that offer this service to small businesses, including: