Smart TaxesSmart Taxes

Cafeteria plan could serve up tax savings

Programs let you deduct medical expenses even if you don't itemize.

By Jeff Schnepper Mar 19, 2010 10:55AM

How’d you like to make the 7.5% medical expense slicer go away?


There’s a way to do that. Do it right and you can deduct the first dollar of your medical expenses even if you don’t itemize.


Normally, you can only deduct your medical expenses if you itemize your deductions on Schedule A.


Even then, you have to reduce your medical deduction by 7.5% of your income, technically your adjusted gross income (AGI). So, if your AGI was $100,000, the first $7,500 in medical expenses is lost. If any expenses survive the 7.5% cut, they increase your exposure to the dreaded Alternative Minimum Tax (AMT).

There’s a way to avoid all of that.


Have your employer establish what’s known as a Flexible Spending Plan, Salary Reduction Plan or Cafeteria Plan. They are all different names for basically the same concept.


You and your employer enter into an arrangement where you reduce your wages by a given amount, say $200 per month or $2,400 for the year. Because that money was never yours, you’re never taxed on it.

But, the money is credited to your reimbursement account. You can be reimbursed, tax free, for any medical expenses (and up to $5,000 in child and dependent care expenses).


Since you were never taxed on the original contribution in the plan, and since the reimbursement is tax-free, it’s as if all of the expenses were fully deducted from what would have been your gross income.


Your employer benefits as well. Any reduction in wages potentially reduces any state and federal payroll taxes that would have been paid. It also cuts your employer’s tax match on Social Security and Medicare taxes.


The down side? It’s use them or lose them. Any dollars not reimbursed by the end of the year (or by March 15 of the next year if the plan provides for that) are lost.


But, at least take what you know you’ll spend -- health insurance payments, expected doctor co-pays, dental work, etc. It will cut your tax burden -- and it’s your money.


The best evidence of how good a deal this is can be found in Congress’ health bill proposals. They want to put a cap of $2,500 on your salary reduction.


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