Couples can get a greater tax break with this flexible spending account strategy
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Working families struggling to pay for childcare could be relieved of the changes to flexible spending accounts in 2021.
The US bailout, President Joe Biden’s $ 1.9 trillion stimulus package, increased childcare support through temporary changes to the FSAs for dependent care.
The bill raised the FSA limits for care recipients from $ 5,000 to $ 10,500 in 2021 and offered a higher tax break on top of the existing rules, leaving more time to spend the money.
As more companies adopt the FSA changes, couples can develop strategies to maximize their tax write-offs, say financial experts.
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Families may not be aware of the increase in the FSA dependent care limit to $ 10,500, especially if their employers have not yet adopted the change.
“Something [companies] have pulled the trigger, others have not yet made up their minds, “said Attorney Evelyn Small Traub, a partner at Troutman Pepper in Richmond, Virginia, where she focuses on employee benefits.
FSA services requiring care
FSAs in need of care reduce an employee’s gross income by depositing money into a special account to cover annual care costs for children or disabled adults.
Families can use this pre-tax money to pay for daycare, after-school programs, work-related babysitting, summer camps, and more.
Since the money comes in before taxes, employees can save on wage taxes.
“A lot of customers don’t know what it is and we talk to them about the benefits,” said certified financial planner Jake Northrup, founder of Experience Your Wealth in Bristol, Rhode Island.
While couples may be ready to sign up for the new FSA limits, they may need to review their overall tax situation before deciding which spouse to choose, he said.
Submit taxes together
“If you file together, the decision is pretty easy,” said Northrup.
For these couples, it usually makes sense to use the lower-income spouse’s FSA, provided both employers offer care-dependent FSAs at the new limit of $ 10,500.
The reason: Low-wage earners may save more on Social Security and Medicare payroll taxes.
Social Security tax (6.2%) applies only to the first $ 142,800 of 2021 income. Medicare tax (1.45%) applies to all income, plus 0.09% for those earning more than $ 200,000.
For example, let’s say one spouse makes $ 225,000 and another makes $ 75,000. The spouse who earns less than $ 142,800 pays a total of 7.65% for Social Security and Medicare taxes.
However, the spouse who earns $ 225,000 pays Medicare (1.45%) plus the additional Medicare (0.09%) on income greater than $ 142,800, lowering that person’s overall tax rate to 2.35%.
In this scenario, the lower-income spouse can save more on payroll taxes by deferring $ 10,500 into their employer’s FSA for dependent care, Northrup said.
Submit taxes separately
“But it is not a given that everyone should file taxes together,” said Northrup.
Some couples file taxes separately to lower payments for income-based student loan repayment plans. Others may part ways to reduce income and qualify for the 2021 tax credits.
In the student loan scenario, it might be better to use the FSA for dependent spouse care with student loans, he said.
Couples may need to enter the numbers to determine which options offer the highest tax savings.
“I definitely recommend talking to a tax advisor about it,” said Northrup.
While companies don’t have to adopt the new FSA limits, employees can be proactive by asking about them now.
Once the company adjusts the FSA limit, employees may only have 14 to 30 days to update their plan, Small Traub said.
Of course, they need to consider how much money they will be spending on dependent care.
Companies may allow FSA rollover until 2022, but that doesn’t extend until 2023. Families could lose a large chunk of money if they don’t plan carefully, she said.