A salary reduction plan allows you to convert potentially non-deductible expenditures into deductible ones. It is a great idea, but only helps if your employer establishes a plan. This column will tell you how.
A salary reduction plan is easy to create. In its simplest form, it is an agreement between you and your employer to reduce your salary by a given amount. For example, assume you are single, making $72,600 a year, and are in the 31% bracket. You and your employer agree to reduce your salary by $10,000 for the year. What's the result?
First, it puts a big smile on your employer's face. He just saved a minimum of $765 in Social Security and Medicare taxes he doesn't have to pay. In addition, he doesn't have to expend any state disability, workman's compensation, or any other payroll taxes on the $10,000 in salary that is not being paid to you.
That's great for your boss, but how about you? You save on the Social Security and Medicare taxes not paid by you. The $765 in savings is not all. Here's where it gets to be fun. In effect, your employer sets up an account for you from which you can get reimbursement for certain expenses with those expenses being reimbursed tax-free to you.
Over the year, you will have access to the $10,000 that you conceded in salary for expense reimbursement. In the beginning of each year, you tell your employer how much you want withheld from your salary and for what purpose. That's why these plans sometimes are referred to as cafeteria plans or flexible spend accounts. You pick and choose which expenses you want reimbursed.
You can select reimbursement for group life insurance payments; health care reimbursement; accident, health care plan, or disability plan premiums; or dependent care assistance programs. You must allocate your salary reduction among dependent care, premium payments, and health care reimbursements.
The reduction amount you have chosen is withheld equally from each paycheck. Under IRS rules, you still may seek reimbursement' for medical expenses equal to the amount you will contribute for the year, even if this amount temporarily exceeds the unused amount set aside in your account from the beginning of the year. By making these reimbursements tax-free, what the salary reduction plan does is to convert all of these expenditures that you would normally incur into "deductible" expenses--whether or not they normally would be allowed as a deduction.
Let's look at dependent care benefits. While...