Like the pre-tax medical contributions, your contributions to the Health Care Flexible Spending Account (HCFSA) and Dependent Care Flexible Spending Account (DCFSA) are deducted from your paycheck before any federal or state income taxes or Medicare contributions are withheld. That means the money is tax-free when you put it into the accounts, and it remains tax-free when you are reimbursed. You never pay taxes on the money (except for local taxes).
The tax savings offered by the HCFSA and DCFSA can be significant, even if you have a small number of eligible expenses. As an example, assume you decide to go ahead with the orthodontia work your dentist recommended for your son. The portion of the expenses that you will have to pay during 2006 total $1,000. By depositing that money in the HCFSA, you could save $250, assuming combined federal and state income taxes and Medicare contributions of 25%. If you were in a 35% combined income tax bracket, your total savings would increase to $350.
Now, let's look at an example where the tax savings can be even greater. Assume you are married, and you and your spouse both work full-time. Your day care expenses for your child total $2,500 a year. If you are in a 25% combined tax bracket, you can pay the $2,500 through the DCFSA and save about $625 a year in taxes. That stays in your pocket. If you were in a 35% combined tax bracket, your savings would increase to about $875.