One of the most popular Workplace benefits are certain accounts which cut your Federal (both Income tax, Social Security tax, and Medicare tax), State, and city tax bill. These accounts are known as either Flexible Spending accounts, often referred to as an FSA, or Pre-Tax Commuter accounts.
A Flexible Spending Account is a dedicated account you put money into that you use to pay for certain out-of-pocket health care costs. You don't pay taxes on this money.
Companies typically offer two types of Flexible spending accounts, a dependent care FSA or a medical FSA.
Dependent Care FSA
With a dependent care FSA, an employee sets aside money to help pay for costs associated with care for the kids while Mom and/or Dad work. Covered services typically include nursery school for young children, after-school programs for older kids and day camp during the summer. Dependent care FSA money, can help pay the costs of any caregiver providing services while you’re at work, such as a home health aide looking after a disabled spouse.
The major benefit of doing this is that all of the money taken out of your paycheck and put into the account is “Pre-Tax". FSA deductions come out of a worker’s paycheck on a pretax basis. That means less of your earnings are subject to tax.
Lets say you put $3,000 in the account to pay for Nursery.
We will also assume a 24% Federal Tax rate;
approximately 7.5 % Social Security and Medicare rate;
and a 6.5% State and local tax rate.
The tax on $3,000 would have been $1,140.
So, you would have only had $1,860 to pay for the Nursery expense.
Now that the Tax code allowed you to set aside the Money “Pre-Tax” the full $3,000 is available.
This is a free $1,140!
A health FSA, is similar. A worker can set aside money to pay for routine items such as health insurance copays, uninsured treatments such as vision care or even over-the-counter drug purchases. The numbers would work out similar to above, except that there is a $2,500 cap on this account.
Using the percentages above, you would save $950 in taxes!
Pre-Tax Commuter Benefit Plan
Finally, a Pre-Tax commuter benefit plan is an account in which an employee designates a portion of salary before taxes (pretax income) to pay for qualified transit, vanpooling, or parking expenses. The Maximum amount is $260 per month for the specific kind of transportation expense you incur. Assuming again the percentages are above for taxes, a worker who needs the full $260 a month would save $1,185 in taxes per year!
Bottom Line: With a little focus and dedication with these percentages, a worker can save approximately $3,275 a year in taxes = Free Money. If the rates were higher the savings would be greater. If the rates were lower the savings would be less, although still substantial!