Tax advantage of FSA reimbursement vs. FSA direct payment

Question

I signed up for an FSA for dependent care from my employer. The company that manages the FSA has informed me that the only way I can use my funds is for me to pay upfront using a regular credit card, then seek reimbursement for the funds out of my FSA account. They won't pay the expense directly.

I'm confused as to how this provides a tax benefit to me. If I pay upfront using after-tax dollars, then get reimbursed using FSA pre-tax dollars, am I actually gaining anything? Wouldn't I need to be able to pay my qualified expenses directly from the FSA account in order to realize a tax benefit?

Maybe I'm confused (which seems to be the whole point of the FSA scheme, but I digress...); I'd appreciate clarification.

Answer 1

If I pay upfront using after-tax dollars, then get reimbursed using FSA pre-tax dollars, am I actually gaining anything?

You are paying upfront with your personal finances (using after-tax dollars), but then you get reimbursed the full amount from your FSA, negating that expense. The reimbursement came from your FSA, which you contributed to with pre-tax money.

The tax savings comes when you put money into the FSA, not when you take money out.

Answer 2

Let's assume you are putting $1,000 in the FSA, and that amount is in the 22% tax bracket.

When that $1,000 was deducted from your pay, your taxable pay was reduced by the same amount. This saved you $220 in federal taxes.

You pay the bill of $1,000, then you withdraw the $1,000 from your FSA.

That means that you paid a $1,000 bill with an amount of money that only cost you $780.

The only issue is that if you delay submitting the paperwork you will feel like you have paid twice. If the bill is paid by credit card it is possible to get the money from the HSA before paying the credit card bill.

Answer 3

Don't classify both as "before tax" and "after tax" - they just confuse the issue in this case.

The amount that went into your FSA reduced your tax burden by your marginal tax rate. So your take-home pay is higher by that tax amount than if your FSA contribution had been taxed. You now have money in the bank and money in the FSA. From there, whether you pay from the bank and then replenish it from the FSA or pay from the FSA directly hos no tax consequence.

Answer 4

Regarding tax benefits: when you contribute $100 into your FSA, your paycheck is reduced by less than $100. For example, your paycheck might only be $75 less than if you didn't put money into the FSA. This means for every $100 you put into your FSA you save $25. It doesn't matter if you pay it and get reimbursed or if you could pay it directly from the FSA. In fact, if you have a CC with cash back you even get an extra 1-2% savings by paying first and getting reimbursed.

You didn't ask this, but the more important question is whether or not the FSA is a good idea for you. You need to run the numbers for both the child care tax credit and also the Dependent Care FSA to see which is better for your situation. There are some no-brainers though, for example: if you have exactly 1 child and your childcare expenses are more than $5K in the calendar year, then you absolutely should sign up for the FSA and you should fund it with a minimum of $2,000 regardless of your income. From there your income will determine if you should put more than $2K into the FSA. Also, if you have two or more children and it makes sense for you to get the FSA fully funded at $5K, don't forget that you still can get the last $1000 from the child care tax credit.