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MEL POTESHMAN At most companies, the end of the year signals a period of open enrollment for joining and making changes to many benefit programs, including flexible spending accounts (FSAs). Authorized under Section 125 of the Internal Revenue Code, flexible spending accounts allow you to set aside a certain percentage of your pre-tax salary to pay for qualified medical expenses that are not covered by insurance, as well as for dependent care costs. FSAs are one of the most cost-effective means to pay for such expenses, and it’s important to take the time now to estimate next year’s expenses as accurately as possible. Here’s how FSAs work: Typically, the amount you choose to set aside for qualified medical and dependent care expenses is deducted from your paycheck each pay period and put into an account for you. Upon submission of the required documentation, your employer reimburses you for those expenses. Because the money you set aside is deducted from your paycheck before taxes, FSAs offer a significant tax benefit. For example, if you’re in the 28 percent tax bracket and you choose to set aside $1,000 for the year, you save $280 in federal income tax. Additional savings are derived from possible reductions in Social Security taxes and state and local income taxes as well. FSAs also reduce your adjusted gross income (AGI), which allows you greater medical and miscellaneous itemized deductions. Flexible spending accounts can be used to cover a wide range of out-of-pocket medical expenses including health insurance deductibles and co-payments, prescription drugs, eyeglasses, contact lenses, and dental work. Expenses for cosmetic surgery, health club membership, and non-prescription drugs are not eligible for reimbursement. Your employer can provide you with a list of medical expenses that qualify for reimbursement. Many employers offer similar flexible spending accounts that allow employees to allocate pre-tax dollars to cover child or elder care expenses, such as day care, before and after school care and day camp. Keep in mind, however, that participation in your employer’s dependent care spending account may affect your eligibility for the child-care tax credit. You must reduce dollar-for-dollar the amount of your dependent care expenses eligible for the credit by the amount excluded from your gross income and allocated to your spending account. Before you sign up for an FSA, you should determine which would give you greater tax savings: taking the child-care tax credit or excluding the expenses from earnings under your employer’s plan. If you’re not sure, you may want to consult your financial advisor. The rules governing FSAs require that you determine how much you want to set aside in 1998 before the end of the year. You’ll want to estimate that figure as closely as possible, because any money that’s left in your FSA is forfeited. Unused funds are not returned to you, and you cannot carry your balance over to next year. Don’t underestimate the value of using an FSA to pay for medical costs your policy doesn’t cover, such as dental work and vision care. Employers must make available the full reimbursement amount whenever reimbursable expenses occur, regardless of how much has been paid into the account. For example, if you agree to an FSA payroll deduction of $100 per month, you are eligible for reimbursement of up to $1,200 for the year; if you incur $1,200 worth of qualified expenses in January, you may submit the full amount for reimbursement, even if you have only paid $100 into the account. You must, of course, continue the deductions from your paycheck through the remainder of the year. Tax breaks for parents Starting in 1998, a new child tax credit is available to parents with children 16 years of age or younger. Thanks to the 1997 Taxpayer Relief Act, taxpayers will receive a $400 credit per qualifying child for tax years beginning in 1998; the credit increases to $500 per child for tax years beginning in 1999 and beyond. This credit is in addition to the dependency exemption and the dependent care credit which helps working parents defray the cost of child care. To be eligible for the child credit, a qualifying child must be 16 years of age or younger at the end of the year and must qualify as your dependent. The credit is first available for the 1998 tax year, which means it can be claimed on the tax return you file in 1999. The child credit applies to each qualifying child. So, for example, a family with three children 16 years of age or younger can take a $1,200 tax credit on their 1998 tax return. The child credit is phased out for married taxpayers filing jointly with adjusted gross incomes (AGI) between $110,000 and $120,000 and for single taxpayers or heads of household with AGIs between $75,000 and $85,000. Here’s how it works: The credit is reduced $50 for each $1,000 of AGI over the $110,000 threshold for married, joint-filing taxpayers ($75,000 for single taxpayers). For example, if you’re married and your AGI is $115,000, your child credit is reduced by $250 ($50 for each thousand over $110,000) to $150. The credit disappears completely when AGI reaches $120,000 for joint filers and $85,000 for single filers. If you expect to take the child care credit, you may want to file a new Form W-4 with your employer in order to claim one or more extra withholding allowances. That way, you can enjoy the extra take-home pay now, rather than waiting until next year to receive the benefit. Mel Poteshman is a certified public accountant and president of Poteshman Consulting International & Co. a West Los Angeles-based business consulting firm.