Adam Chodorow is a Professor of Law at Arizona State University. I invited him to do a guest post on a topic of his choice. He and I seem to share a taste for frivolity, but here he is putting forth a serious proposal.
Charitable FSAs: A Proposal to Combine Healthcare and Charitable Giving Tax Provisions
Now that the Supreme Court has found the Affordable Care Act constitutional, it’s time to get back to the business of actually improving our health care system. Given the polarized positions of the two major parties, compromise on major issues seems beyond reach. Nonetheless, unless gridlock is absolute, there should be some areas of agreement where change is still possible. I would like to offer here a modest tweak to existing law that would likely garner strong bipartisan support in a less polarized environment.
Raise your hand if you have access to a healthcare Flexible Spending Account (FSA) through work. Raise the other hand if it is a source of significant frustration. Okay, put your hands down. For those unfamiliar with FSAs, let me explain. FSAs create tax incentives for people to save for their medical needs. Before the year begins, employees notify their employer of how much they want to contribute to their FSAs. Amounts contributed are exempt from income and payroll taxes. When employees incur qualified medical expenses, they send their receipts to the employer or plan administrator, who reimburses the expenses, again without any tax being paid. That’s the good news.
For reasons too complicated to get into here, FSAs have a fatal flaw. Taxpayers are not allowed to change their decision to contribute or the amount they contribute once the year has begun. Thus, if an employee’s medical expenses are less than expected, the FSA will be over funded. This would not be terribly problematic, except that, and here’s the kicker, any money left in an FSA at the end of the year is forfeited to one’s employer.
As a result of this use-it-or-lose-it rule, many people decline to participate in the program. Others spend hours trying to divine what their medical costs will be over the next year, often underfunding their accounts to avoid the risk of forfeiture. Those who guess wrong and have money left over at the end of the year typically rush out to spend it on items they don’t need.
For years, brave politicians have introduced legislation to allow taxpayers to roll over any unused funds to the next year, but to no avail. Efforts to eliminate FSAs as part of the new healthcare law also failed, though Congress did impose a $2,500 annual contribution limit.
Insofar as FSAs appear to be here to stay, why not make them more effective? As I proposed in a recent article, Congress should amend the rules covering FSAs to allow taxpayers to donate unused amounts at year-end to the charity of their choice. Doing so would accomplish a number of goals. First, it lessens the use-it-or-lose-it barrier to FSA participation. While taxpayers don’t get to keep unused funds, they do get to direct their use. Taxpayers are more likely to fund their FSAs in accordance with their anticipated medical needs, and not spend so much time trying to divine those needs in advance, if they know that any unused money will go to a worthy cause. Second, the proposal may increase charitable donations, something both parties should support. Finally, because amounts donated from FSAs have not been taxed, donating through an FSA affords donors the equivalent of an above-the-line deduction, even if they take the standard deduction. Both Democratic and Republican administrations have floated the idea of creating a limited above-the-line deduction for charitable donations.
This proposal should appeal to taxpayers, charities, Democrats and Republicans alike. Who knows, cooperation on issues like this could help break the partisan logjam and lead to greater cooperation on other, more weighty issues. A person is allowed to dream, isn’t he?
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I was never that enthusiastic about FSAs, although I remembering taking advantage of one, during a period where we were having predictable out-of-pocket medical expenses. Professor Chodrow’s proposal would throw in another administrative complexity. I don’t know. I just can’t work up a lot of enthusiasm. His suggestions about addressing the tax issues raised by the coming zombie apocalypse and the undead in general are another matter entirely. I really appreciate his first visit here, though, and hope it will not be his last.
You can follow me on twitter @peterreillycpa.
Originally published on Forbes.com on August 3rd, 2012