Year End Planning for Employees

As we near the end of the year, you may be faced with a number of choices that can save you money on your taxes, both this year and next. If you work as an employee, you have some special considerations to take into account. To help you take advantage of the tax saving opportunities available to you, we have put together a list of items to consider. Please feel free to contact us if you need additional information on any of these items.

Health Flexible Spending Accounts (FSA): If your employer offers FSA accounts, you have the opportunity to save money by related to medical expenses. You contribute some money to the account from each paycheck, and then submit medical expenses for reimbursement to have the money returned to you. This saves you money because you don't pay income tax on all the money you contribute to a health FSA. In contrast, medical expenses can only be deducted on your tax return if you itemize deductions on your return, and only to the extent that the expenses exceed 7.5% of your adjusted gross income. In addition, you can use health FSA funds to get a tax-free reimbursement on over-the-counter medications and other items that would not be qualify deductible as medical expenses.

If you already have a health FSA, remember to check the balance before the end of this year, as funds not used by the end of the plan year (often December 31) will be forfeited. Remember that you can get tax-free reimbursements for aspirin, antacids, cold medicine, contact lens solutions, and other over-the-counter items. Many plans will also reimburse you for the miles you drive for medical reasons. Your plan should have a list of what types of items qualify for reimbursement and what documentation they require. (Some plans do offer a grace period to extend the time that expenses can be incurred.)

Examine your medical expenditures for this year to help you determine how much to set aside for next year. Don't forget to take into account any change in circumstances that will affect your medical expenses for 2010.

Dependent Care Flexible Spending Accounts: Your employer may also offer a dependent care FSA. These are similar to health FSAs, allowing you to set money aside for dependent care. Depending on your particular circumstances, a dependent care FSA may save you more money on your taxes than claiming the Dependent Care Credit. For example, if you are in a high tax bracket and/or have only one dependent and more than $3,000 of dependent care expenses, an FSA is often a better choice.

It is important that you remember that, as with health FSAs, money not used by the end of the year is forfeited. Plan accordingly when setting funds aside for next year. Also, expenses can only be incurred for dependents who will be under age 13 at the end of the tear. Finally, if you are married, you can only qualify for a dependent care FSA (or the dependent care credit) if both you are your spouse are working.

Adoption Assistance Flexible Spending Accounts: These accounts work in a similar fashion to the other types of FSAs. Pre-tax money is set aside from your paycheck and can be used to reimburse yourself for qualified adoption expenses. Money not spent by the end of the year is forfeited. If you are considering participating in an adoption FSA, consider that predicting the amount and timing of adoption expenses is often more difficult than forecasting medical or dependent care expenses, so they may be a higher risk of losing funds contributed to an adoption FSA. It may be prudent to be conservative on the amount of money you choose to contribute. However, adoption expenses in excess of what is contributed to the FSA may qualify for other tax benefits.

Adjustments to Withholding: If typically owe federal or state income taxes when you file, you may be subject to an underpayment penalty. Increasing your withholding now may eliminate or reduce any penalty. Of special note this year, the Making Work Pay Credit automatically lowered the amount of tax being withheld for all employees. However, some people will not be eligible to the credit and may find that they owe taxes this year, even if they have not in the past. You should especially review your withholding if you and your spouse both work, or if either of you work multiple jobs, or if you can be claimed as a dependent on another person's tax return.

If you typically owe state or local income taxes when you file your tax return, ask your employer to increase your state withholding, or make an estimated tax payment before the end of the year, to potentially make those taxes deductible in 2009.

Retirement Plan Contributions: More than 20% of employees who are eligible to participate in an employer's retirement plan do not do so. Of those that do participate, a much smaller number make the full contribution they are allowed each year. Contributions are a vital part of your retirement strategy, and will save you money on taxes now. In addition, many employers match some portion of your contributions with additional money. Now is the time to adjust your contribution level (or enroll, if you are not currently participating).

Some employers now offer the option of automatically increasing your contribution when you receive a raise. If yours does not, consider doing so yourself. If your employer does not offer a retirement plan, or if you work but your spouse does not, a traditional or Roth Individual Retirement Arrangement (IRA) account may make sense.

(November 15, 2009)

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