Thereís good news both for employees with flexible savings accounts (FSAs) and for those who declined to participate in the past because of the use-it-or-lose it rule. Under IRS regulations that were in effect for close to 20 years, any unclaimed funds remaining in a participantís flexible spending account at the end of the plan year were forfeited.

That use-it-or-lose-it obstacle became less restrictive last year when the IRS announced that the deadline for FSA spending could be extended by two-and-one-half months, reports the Minnesota Society of CPAs (MNCPA). This means that a participant now has a two-and-one-half month grace period during which any unused contributions can be used, provided that his or her employer has amended the planís documents to offer this. Understanding this and other rules can help you make the most of FSAs.

Companies generally offer two types of flexible spending accounts: a medical FSA and a dependent care FSA. You may participate in one or both of the flexible spending accounts, but you cannot transfer money between the accounts.

REIMBURSEMENT FOR QUALIFIED MEDICAL EXPENSES

With a medical flexible spending account, over the course of the year, you set aside a portion of your pay, before taxes, to be contributed to your medical FSA. These funds can be used to pay for out-of-pocket medical, dental, hearing, and vision care expenses that are not covered by your health plan(s). The contributions you make to your FSA are deducted from your pay before federal, state, and payroll taxes are calculated and are not included in taxable wages reported to the IRS. By paying for your out-of-pocket expenses with pre-tax dollars, you can save hundreds of dollars or more each year. Of course, the medical expenses for which you wish to seek, reimbursement must be adequately substantiated.

Eligible expenses include health care plan deductibles, co-payments, and any other medical expenses not covered by your health insurance plan. Examples of eligible expenses include fees for prescription drugs and over-the-counter medications, eyeglasses, contact lenses and dental expenses.

Once each year, during an open enrollment period, you determine how much you want to contribute. The IRS does not set a maximum contribution limit for FSAs; employers are free to set their own limits.

The amount you choose to have deducted from your paycheck remains the same throughout the year unless there is a change in your employment or family status (such as the birth of a child or the death of a spouse) that is specified by your plan.

During the plan period, as you incur out-of-pocket expenses for qualifying health care, you provide proof of payment to your FSA plan administrator who will then issue a check for reimbursement.

You can withdraw up to the amount of your annual contribution to pay qualified medical expenses. This is true even if the amount of your withdrawal exceeds the amount you currently have in the account.

DEPENDENT CARE FSA

The dependent care FSA helps you to pay for child care services that make it possible for you and your spouse (if married) to work. Under the dependent care FSA rules, you may be reimbursed for childcare for a child under age 13, who lives with you and who is your tax dependent. You are also eligible for a dependent care FSA if you have a family member, including your spouse, who is physically or mentally incapable of self-care and who qualifies as a dependent on your federal tax return. Currently, the IRS allows you to contribute up to $5,000 per year ($2,500 per year if married and filing separately) to a dependent care FSA.

Keep in mind that you will need to choose between a dependent care FSA and the dependent care tax credit because the tax credit maximum is reduced dollar for dollar for each dollar placed into a reimbursement account.

Generally, if your income tax bracket is 15 percent or less, it would be more advantageous for you to take the tax credit.

A CPA can help you better understand how to effectively set aside money in an FSA and how to manage the tax implications of your decisions.