Question

Heather is a fulltime employee of the Drake Company and participates in the company's flexible spending plan that is available to all employees. Which of the following is correct?

a. Heather reduced her salary by $1,200, actually spent $1,500, and received only $1,200 as reimbursement for her medical expenses. Heather's gross income will be reduced by $1,500.
b. Heather reduced her salary by $1,200, and received only $900 as reimbursement for her actual medical expenses. She is not refunded the $300 remaining balance, but her gross income is reduced by $1,200.
c. Heather reduced her salary by $1,200, and received only $800 as reimbursement for her medical expenses. She is not refunded the $400. Her gross income is reduced by $800.
d. Heather reduced her salary by $1,200, and received only $900 as reimbursement for her medical expenses. She forfeits the $300. Her gross income is reduced by $300.
e. None of these.

Answer 1

Heather's gross income is reduced by the full amount she elected to contribute to her flexible spending account ($1,200), regardless of the amount she spent ($900) or the unused amount forfeited ($300).

Step-by-step explanation:

The correct answer to the question about Heather's participation in the company's flexible spending plan is: b. Heather reduced her salary by $1,200, and received only $900 as reimbursement for her actual medical expenses. She is not refunded the $300 remaining balance, but her gross income is reduced by $1,200.

Flexible spending accounts (FSAs) are special accounts in the United States that allow an employee to set aside a portion of earnings to pay for qualified expenses, most commonly for medical expenses but often for dependent care or other expenses. Money deducted from an employee's pay into an FSA is not subject to payroll taxes, resulting in a substantial payroll tax savings. If Heather elected to reduce her salary by $1,200, that full amount is considered pre-tax and lowers her taxable income regardless of how much is reimbursed.

If she used only $900 of this for qualified expenses, the unused portion ($300 in Heather's case) does not get refunded or carried over; it is forfeited according to the 'use-it-or-lose-it' rule that governs FSAs. Therefore, Heather's gross income includes a $1,200 reduction for the FSA contribution, not the amount reimbursed ($900) or forfeited ($300).