FYI: FSAs are SS/Medicaid/FICA Exempt

For Your Information:

I learned something today that I don't believe is common knowledge or is perhaps glossed over. Flexible Spending Accounts are exempt from Fica, SS, and Medicaid taxes in additional to Federal Income Tax.

This is an interesting and unique note, because Traditional IRAs, HSAs, 401ks and just about every other tax deferred vehicle I can think of, is NOT exempt from SS/FICA/Mcaid. This also explains what employers get out of the deal. They get to pay you 7.5% less on the FSA amount.

Thus when calculating the value of an FSA, it becomes more valuable by about 8%.

As far as your W2 is concerned, FSA withdrawals are taken directly from your gross pay before anything else comes out.

Green this thread if it's new information to you. Red the thread if everyone already knows and I was the last to find out.

tripleB said: This is an interesting and unique note, because Traditional IRAs, HSAs, 401ks and just about every other tax deferred vehicle I can think of, is NOT exempt from SS/FICA/Mcaid.You are wrong on this one. Employer HSA contributions are generally exempt from payroll taxes. Employee elective contributions are exempt from payroll taxes as long as the employer's plan is set up in a certain way.

Publication 15:
Pub 15 said: Health Savings Accounts and medical savings accounts. Your contributions to an employee's Health Savings Account (HSA) or Archer medical savings account (MSA) are not subject to social security, Medicare, or FUTA taxes, or federal income tax withholding if it is reasonable to believe at the time of payment of the contributions they will be excludable from the income of the employee. To the extent it is not reasonable to believe they will be excludable, your contributions are subject to these taxes. Employee contributions to their HSAs or MSAs through a payroll deduction plan must be included in wages and are subject to social security, Medicare, and FUTA taxes and income tax withholding. However, HSA contributions made under a salary reduction arrangement in a section 125 cafeteria plan are not wages and are not subject to employment taxes or withholding. For more information, see the Instructions for Form 8889, Health Savings Accounts.

You also save on your State and Local income taxes.

So have you figured out a scheme to make a profit out of this?

Dependent Care FSA is also exempt from SS/Medicare.

On the other hand, HSA contribution is subject to CA state tax.

fattysaver said: Whatever name you are posting under in this thread, How about changing the title of the thread to 'FSA for Fun and Profit'

slc39 said: The only caveat is that it directly affects your Social Security income when retiring. Not a big deal if you are withholding a couple hundred for the year. A bit more significant if you are putting thousands into your FSA.
For most people of FW, it will probably mean the difference between qualifying for $X and getting $0 due to means testing, or qualifying for 95% of $X and getting $0 due to means testing. It might be confiscatory taxes rather than means testing, but that would have the same effect.

I didn't think that self employed are eligible to open up an FSA. That also includes partners at big firms, if you pay self employment taxes, you can't open up an FSA.

theman2 said: Employer HSA contributions are generally exempt from payroll taxes. Employee elective contributions are exempt from payroll taxes as long as the employer's plan is set up in a certain way.Just to clarify this as well, payroll taxes are only assessed on payroll rather than on employer contributions on your behalf. So, if you are earning $100 and are electing to contribute $10 towards an HSA, then the entire $100 is subject to payroll taxes, although you may be eligible to exclude the $10 from federal and state income taxes (Social Security and Medicare taxes would still apply, however). If, however, your employer, pursuant to a salary reduction agreement executed by the employee, only pays you $90 and contributes $10 on your behalf towards an HSA/FSA, the $10 is not subject to any payroll taxes, including Social Security and Medicare taxes, because your wages were only $90.

My former firm used to allow us to take advantage of this distinction to exceed the standard 401(k) contribution limit. They did that by offering a salary reduction agreement whereby they would contribute a certain percentage of your salary to a 401(k) on your behalf. Because that amount did not count towards our wages, it also did not count towards the annual 401(k) contribution cap, so we had the option of contributing far more than the standard annual 401(k) contribution limit.

DaveHanson said: Note that even in a scenario like his, someone might be better off having the higher-paid spouse have the FSA, provided that the employer won't make the contribution for you (as was the case in my old teaching job). That's because geo would at least save on the uncapped medicare tax...Dave, if you do not have a salary reduction agreement in place with the employer whereby your salary is reduced by the amount of your desired HSA/FSA contribution and the employer then makes the contribution on your behalf, the entire amount of employee's contribution is "wages," which is subject to FICA. So, if you did not have the option and did not in fact sign a salary reduction agreement in your old teaching job, the entire amount of your contribution should have been subject to FICA.

DaveHanson said: In my old job, I did sign an agreement by which a part of my salary would go to an FSA, which my employer did not otherwise contribute to. That portion of salary was not subject to FICA tax, so both me and the university employing me paid less FICA tax than we would have otherwise. I'm not sure whether we're disagreeing on anything or not...We are not disagreeing on anything I am just pointing out that if your employer's plan is NOT set up to allow you to sign a salary reduction agreement whereby your employer would then make the contribution on your behalf, which is what I thought you had said above about your previous employer's plan, then your HSA/FSA contributions would still be subject to FICA taxes.

theman2 said: tripleB said: This is an interesting and unique note, because Traditional IRAs, HSAs, 401ks and just about every other tax deferred vehicle I can think of, is NOT exempt from SS/FICA/Mcaid.You are wrong on this one. Employer HSA contributions are generally exempt from payroll taxes. Employee elective contributions are exempt from payroll taxes as long as the employer's plan is set up in a certain way.

Publication 15:
Pub 15 said: Health Savings Accounts and medical savings accounts. Your contributions to an employee's Health Savings Account (HSA) or Archer medical savings account (MSA) are not subject to social security, Medicare, or FUTA taxes, or federal income tax withholding if it is reasonable to believe at the time of payment of the contributions they will be excludable from the income of the employee. To the extent it is not reasonable to believe they will be excludable, your contributions are subject to these taxes. Employee contributions to their HSAs or MSAs through a payroll deduction plan must be included in wages and are subject to social security, Medicare, and FUTA taxes and income tax withholding. However, HSA contributions made under a salary reduction arrangement in a section 125 cafeteria plan are not wages and are not subject to employment taxes or withholding. For more information, see the Instructions for Form 8889, Health Savings Accounts.

Hmmm I might have to look into contributing via my employers plan despite the Torrid 0.15% rate just to save on payroll tax.

citifan said: nic3456 said: You also save on your State and Local income taxes.

Not in some states. At least not in NJ From what I understand, New Jersey and Puerto Rico are the only two places in this country that impose state income taxes on contributions to both health care and dependant care FSA's. Pennsylvania imposes state income taxes on contributions to dependant care FSA's but not health care FSA's. I think that every other state exempts all FSA contributions from state income taxes.

bump

geo123 said: NorthStar2020 said: Don't know about FICA but SS and Medicaid taxes are only taxed upto a certain income (around 100K +/- 5K) and not taxed above that income. Just a couple of clarifications. FICA stands for the Federal Insurance Contributions Act, which is an act requiring employers and employees to pay social security and medicare taxes. In other words, FICA is not a separate tax that's in addition to social security and medicare taxes but is a term that's used to describe those two taxes.

In 2010 the social security wage cap is $106,800, the same as it was in 2009 (it normally goes up every year). This means that in 2010 wages above $106,800 are not subject to the social security tax. The reason for this cap is the fact that social security benefits are also capped and the benefit cap for the year is reached at these incomes levels. Medicare tax does not have a wage cap, so you pay the tax regardless of how much money you make.

Finally, the fact that HSA/FSA contributions are deducted from your income before social security and medicare taxes is of special interest to couples with significant income disparity. In other words, if one of you earns wages below the social security wage cap for the year and the other person's wages exceed that cap, if you open an HSA/FSA only in the name of the person earning the lower wage, you will save an amount equal to the social security tax on that contribution. If, however, you open the HSA/FSA in the name of the person earning the higher wage, you will not save any social security taxes because the person's income is already above the social security wage cap. My wife and I use this strategy every year, since she is a resident making a slave wage and my income significantly exceeds the social security wage cap, so we open HSA/FSA's solely in her name. By the way, spousal HSA/FSA contributions can be used towards eligible expenses of both spouses, so you don't have to worry about the spouse without an HSA/FSA not being able to take advantage of it.

Thank you for a very useful observation. May I ask some questions using an example?

Let's say spouse A is making $150K, and spouse B is making $50K (all per annum).

You are suggesting that spouse B should be the one to fund an HSA, right? And second, that spouse should fund the full amount for FAMILY, right?

Let's say family contribution limit is $6000. Then if spouse B funds the $6K, then savings are roughly $6K x 7%, $400. On the other hand, if spouse A did the funding, then there will be no such savings.

Is my understanding correct?

TIA.

tolamapS said: Thank you for a very useful observation. May I ask some questions using an example? Let's say spouse A is making $150K, and spouse B is making $50K (all per annum). You are suggesting that spouse B should be the one to fund an HSA, right? And second, that spouse should fund the full amount for FAMILY, right? Let's say family contribution limit is $6000. Then if spouse B funds the $6K, then savings are roughly $6K x 7%, $400. On the other hand, if spouse A did the funding, then there will be no such savings. Is my understanding correct? TIA.

Yes, I think your understanding is correct. I am sure geo123 can confirm or elaborate.

We are doing exactly the same thing. In our case, we have FSA, not HSA.

Spouse A earns more than SS wage cap, and spouse B earns less than the SS wage cap. So, spouse B elects to have FSA under her name in order to reduce FICA taxes. The drawback is that she losses some of her SS wages and might have a slightly reduced SS benefits (the SS benefit calculations are based on the average of the 35 highest years of earnings). In our case, the savings outweigh the slight reduction of SS benefits she will get because part of her SS benefits will likely be taxed anyway due to other income sources such as interest/dividend when she retires.

If you have dependent care reimbursement program at work, the same theory applies as well. Spouse B will not pay FICA for that pot of salary if she elects to have the plan under her. Overall, we save taxes by having the lower earner in the family elects to have the FSA and dependent care plans.

There is another trick if both spouses are able to elect dependent care plans. When comes tax time, you have to pay federal taxes for the excess contribution though. But, you save FICA taxes.

mimi6789 said: There is another trick if both spouses are able to elect dependent care plans. When comes tax time, you have to pay federal taxes for the excess contribution though. But, you save FICA taxes.Well, in your example, this strategy wouldn't save you anything in social security taxes because one of the spouses is already over the social security wage cap.