Tax Deductibility of Forfeited Balances

[Guest loricraun]

Here is an interesting question regarding the tax deductibility of FSA contributions:

A participant in a FSA account makes an annual declaration of $1,000 in 2003. Throughout the course of the plan year she has $1,000 payroll deducted from her paycheck. The plan year ends, the grace period is over, and the employee has only claimed $700 worth of reimbursement from her account. She has now forfeited $300 (use it or lose it) into the plan. The employee’s W2 shows the full $1,000 as a pre-tax deduction.

This employee’s tax advisor says that she should not have taken the full $1,000 pre-tax deduction since she only received reimbursement for $700. He is advising her that she should have only taken $700 as a pre-tax deduction.

I am not a CPA, but this does not seem right to me. I feel that she should receive the full $1,000 as a pre-tax deduction. I think whether or not she received her full re-imbursement amount or forfeited an amount is immaterial.

Does anyone agree or disagree with this? Cited references would be very helpful.

Thanks!

[david rigby]

Probably the individual will want advice from someone who should know, but I thought deductions from income were based on the deduction in the paycheck, not the amount of reimbursement. If the person is deducting an additional $1000 (or $700), perhaps a new "tax advisor" is needed.

[E as in ERISA]

It's the same as if you had $1,000 deducted for insurance premiums and never made a claim. Your taxable income is reduced by the full $1,000 even though you never got any benefit.

[oriecat]

Agreed. The pretax amount for a medical FSA doesn't even have to show on the W-2, only DCAP amounts do, so how would this 'tax advisor' deal with it then?

I'm curious what this advisor is thinking... if the ee wasn't able to pretax the $300, not only would she be losing the $300 that she didn't claim reimbursement, she would then owe taxes on it, since it couldn't be pretaxed, so she would end up losing out of probably $400 instead. Sometimes I start to think anyone can just call themselves a 'tax advisor' and start screwing up everyones returns...

[J2D2]

I agree with the previous responses. Maybe I'm too hung-up on semantics, but the taxpayer here is not "deducting" anything; she is simply reporting the Box 1 (?) amount shown on her W-2 which is net of the pre-tax deferral into the FSA. It would be interesting to know how the tax advisor proposes to report the $300 that is being added-back to her income, since that amount hasn't been reported anywhere, by anyone.

[mbozek]

There are some tax advisors who know nothing about tax law. The participant is taxed only on W-2 income and and amounts left in the participants FSA after the end of the year are not included in the participant's income because they are forefeited.