Personal Finance

2016 FSA Changes

FSAs let you save taxes on healthcare expenses. Image source: Stockmonkeys.

Millions of employees use flexible spending accounts to get valuable tax benefits on their healthcare expenses. From year to year, FSAs typically see minor changes in the laws and regulations that govern them, and it's important to make sure you stay updated to make sure you're using your FSA to the full extent possible. Let's take a closer look at flexible spending accounts and what changes 2016 will bring to key FSA provisions.

A lull in inflation

The most typical FSA change employees see is in the amount of money they're allowed to set aside on a pre-tax basis toward their healthcare expenses. The 2015 limit was $2,550, and that amount is subject to adjustment every year to reflect changes in inflation.

However, because inflation has been subdued during 2015, the IRS made no index-related adjustment to the limits on pre-tax employee flexible spending account contributions. Employees will once again be eligible to set aside up to $2,550 to an FSA in 2016.

The big benefit for employees is that amounts contributed to FSAs are excluded from wages both for federal income tax and payroll tax purposes. Moreover, as long as you spend the money on qualifying healthcare-related expenses, the ensuing distributions from your FSA doesn't trigger any tax. The net effect is savings of as much as 50% for high-income taxpayers on the amount contributed.

Check for carry-forward treatment

Until recently, employees lost any money they left unused in their FSA after the end of the year, following a short grace period of about two-and-a-half months. In 2013, the IRS announced a new rule that created a limited exception to the "use it or lose it" rule, allowing participants to carry forward up to $500 for use in future years.

There are a couple tricks to the provision to keep in mind. First, even though the IRS approves of the use of the $500 carry-forward rule, it doesn't apply to your FSA unless your employer specifically amends its plan to adopt the provision. Over time, more employers have been adopting the provision, but it's still worth checking with your HR department to find out if you're eligible or if your employer intends to adopt the provision going forward for 2016.

In addition, employers can't offer both the grace period and the carry-forward rule. Instead, they have to choose one or the other. That has led some employers to resist adding the carry-forward rule, even though many participants might see it as the preferable option.

Know the difference between FSA types

Although the healthcare FSA gets most of the attention among workers, there's also another type of flexible spending account. Child and dependent care FSAs let you save on a pre-tax basis to cover the expenses of day care for children under 13 or for similar care for senior citizens or older children who are unable to care for themselves.

The limits on dependent care FSAs are different from those governing healthcare FSAs. Total contributions to a dependent care FSA can't exceed $5,000, and married couples have to split the family $5,000 limit between their two FSAs. Moreover, both spouses in a married couple have to work to take advantage of the provision, unless the non-working spouse is a full-time student or has a disability. If one spouse makes less than $5,000 in earnings, then the limit falls to match what that spouse earned during the year.

There aren't many FSA changes taking effect for 2016, but you still need to pay attention to your flexible spending account to make sure it works the way you want and that you choose the right amounts to set aside. Using an FSA effectively can make a big difference in your tax bill.

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The article 2016 FSA Changes originally appeared on Fool.com.

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