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What You Need to Know About FSA Taxes in 2016

By Dan Caplinger - Apr 10, 2016 at 8:22PM

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Learn more about you can use flexible spending accounts to save on your tax bill.

Image source: Stockmonkeys.

One of the biggest tax breaks available to many regular workers is the flexible spending account. If you have an FSA, you can cover medical expenses while saving on several different types of taxes at the very same time. Below, you'll learn more about flexible spending accounts and how you can use them to maximum advantage.

What an FSA is and why you should use it
A flexible spending account lets you divert money from your paycheck that you intend to use for future medical expenses. Later on, after you've received medical care, you can withdraw money from your FSA either to pay those expenses directly or to reimburse you for the money you already spent paying them.

The primary benefit of FSAs is that you can set aside pretax money for your healthcare expenses. Not only do you not have to pay income tax on money deposited in an FSA, but you also avoid paying payroll taxes on that money as well. That's a tax break that most other tax-favored vehicles can't match.

What you can spend FSA money on
The medical expenses you can use FSA money toward are quite varied. Prescription medications are covered, and if you get a doctor to write a prescription, you can also pay for over-the-counter medicines with money from a flexible spending account. Medical equipment such as crutches, supplies like bandages, and diagnostic devices like blood sugar test kits are also permissible expenses for reimbursement from an FSA.

If your health insurance charges you a copayment or deductible for services like doctor visits or hospital stays, then you're allowed to pay those amounts from your FSA. What you can't pay, though, are insurance premiums themselves.

You can also pay for medical expenses for family members from your FSA. If you're married, your spouse's expenses can be covered, as well as those of any dependents that you claim.

Limits on FSAs
FSAs do come with some restrictions and limitations. Perhaps the most important one is that for the most part, you need to spend down your FSA money each year. Until recently, if you didn't spend every single penny of your flexible spending account, you forfeited whatever was left. That often led to extravagant spending at the end of the year in order to use up the remaining FSA balance.

Recently, though, the IRS started giving people a choice of two different options that helped make FSAs more useful. Your employer can choose to provide a grace period of up to two-and-a-half additional months at the beginning of the following year in order to give workers more time to use up their remaining FSA money from the previous year. Alternatively, employers can allow you to carry forward up to $500 of your FSA money from last year into the current year. Employers aren't allowed to give their workers both options, and some employers choose not to provide either one to their employees.

There's a maximum amount you can contribute to an FSA. For 2016, that amount is $2,550. In some cases, employers choose to make contributions toward their workers' FSAs. Any employer contributions don't count toward the limits on employee contributions, but they're subject to the same forfeiture rules as any other contributions if you don't use them by the appropriate deadline.

Finally, there are some people who don't qualify for FSAs. If you're on Medicare, you're not allowed to use an FSA. Similarly, flexible spending accounts aren't available in conjunction with insurance plans offered by the insurance marketplace under Obamacare.

Flexible spending accounts are a common fringe benefit that employers offer, and many people underestimate their value. An FSA can be one of the richest tax breaks you'll ever get, and it pays to use it properly.

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