The way these plans work is that you voluntarily decrease your income by a certain amount, generally paycheck by paycheck, and that amount is placed in a separate account. Over the course of the calendar year, you can request reimbursement from your FSA funds for qualified expenses that you’ve incurred.
If it’s a health-care FSA account, you can request reimbursement for your healthcare deductibles, co-payments, and co-insurance costs – literally any health-care expense that is not covered (paid) by other insurance. There are limits, though: beginning with 2011, you cannot be reimbursed for non-prescription (over the counter) medications.
If the FSA account is for dependent-care expenses, you can request reimbursement for your qualified child-care or adult daycare expenses for your dependents.
The income that you have diverted into the FSA account is pre-tax (just like your 401(k) contributions), so your income is reduced when you participate in these plans. The income is still subject to Social Security and Medicare tax, but not ordinary income tax.
Generally speaking, most FSA plans are set up to allow for a 2½ month grace period for reimbursement from the plans. This means that, for any particular calendar year that you are participating in a FSA plan, you must request reimbursement of your funds by March 15 of the following year. If you do not request your funds by this deadline, you lose the opportunity to retrieve these funds forever.
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