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Thursday, October 22, 2009

A Tax Loop Hole for the Average Guy (or Gal)

Have you ever noticed that it's virtually impossible to meet the 7.5% of Adjusted Gross Income (AGI) cut-off to deduct medical expenses from your income tax? You can save every receipt for every conceivable medical expense - from mileage driven to the doctor to your annual family health insurance deductible - and, unless you have some catastrophic disease, the receipts will almost never add up to 7.5% of your adjusted gross income.

Don't believe me? Let's say you make a modest income of $30,000/year. One percent of that is $300.00, so seven percent would be $2100.00 and 7.5 % would be roughly $2250.00 (if you were watching closely, I just showed you how to do that calculation in your head because I was too lazy to open the Windows Calculator). If you make more than $30k/year, your threshold for deducting medical expenses goes up from there. And, that's just the threshold - you can only deduct expenses beyond that amount. Hardly worth the effort you'll put into trying to keep track of all those receipts all year and adding them up on April 14th.

An FSA is a back door around the 7.5% deductible threshold. You have money taken out of your check BEFORE taxes and put into the FSA. Then, you use the FSA money to pay for any medical expenses you incur during the year. You do need to keep receipts, but only until you're ready to submit them to your FSA provider. When you have a medical expense - virtually ANY medical expense - you send a claim form and a receipt in and they send you a check. It's like being able to deduct your medical expenses without meeting the 7.5% deductible threshold.

Here's another cool thing about the FSA. You decide how much you're going to put in for the whole year and equal installments are taken out of every paycheck. For example, let's say you decide to put $1200 into your FSA and you get paid every two weeks; they'll take $50 out of each paycheck for the whole year (which adds up to $1200). Here's the cool part: the entire $1200 is available to you right away! If you spend the entire $1200 in the first month, you can be reimbursed without waiting until the end of the year. So, besides the tax advantage, it's also like financing your annual medical expenses interest-free.

The only tricky part that I've found - and it's not significant - is trying to guess how much you'll spend on medical expenses in a year. You don't want to put too much in the FSA because if you don't spend it you lose it. So, I lowballed my guess. Basically I know I'm very likely going to pay out at least my individual medical deductible and some fairly regular prescription expenses. Plus, I know I'll send the whole family for two regular dentist appointments for which I have a copay. I just sort of added up a rough estimate of what that would cost and made that my FSA contribution for this year. If I underestimated, I can adjust later or just suck it up and pay with after-tax dollars from my pocket. Again, the important thing is not to over-fund your FSA because you'll lose the unused money.

What amazed me was the vast range of things I can pay for out of my FSA. For starters, any deductibles or copays on my medical or dental insurance, including prescription medication copays, can be paid out of my FSA. Virtually anything else that you can reasonably consider a medical related expense is also included: bandages, antiseptic, antibiotic creams, over-the-counter medications (with a few exceptions), etc.

You won't get wealthy by using an FSA, and not every employer even offers this benefit. But, if your employer offers an FSA (flexible spending account) as part of your benefits package, TAKE IT.

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