How do I deduct FSA payments I made as part of COBRA? FSA payments are generally tax deductible. My W2's taxed income deducts only those FSA payments made via payroll.

[tlaritz]

I retired in July 2016.  I had a FSA with my employer.  Contributions to FSA are tax deductible.  Thru payroll, $1350 was contributed to my FSA.  My taxable income reported on my W2 reflects that $1350.

However, I continued my medical and FSA thru COBRA.  I made an additional $1250 contribution to my FSA via the COBRA administrator, who I paid directly.  My employer has no insight into these payments, and cannot therefore reduce my taxable income reported on the W2 by the $1250.

How can I reflect in my tax return a reduction in taxable income for these FSA contributions which did not "flow thru" my previous employer?

[dmertz]

"I made an additional $1250 contribution to my FSA via the COBRA administrator, who I paid directly."

Is that permitted?  I don't think that it is.

[tlaritz]

Yes it is permitted; I'd argue that the entire point of COBRA is to allow for uninterrupted coverage of medical-related benefits, including FSA.  I have the receipts from both the COBRA and FSA administrators supporting that the FSA contributions, which I paid to the COBRA administrator, were credited to my FSA account.

[Opus 17]

The information I read indicated that the FSA deposits are included as part of your COBRA insurance premium.  In that case, since you are paying the premiums from after-tax dollars, the entire insurance premium is an eligible expense to deduct as a medical expense (subject to the 10% rule of course.)

The net effect is that you are taking a tax deduction for after tax dollars being put into the account where they mingle with the other pre-tax dollars, in the end, all the money in the FSA ends up be pre- or un-taxed.  Then any costs that are reimbursed from the FSA are not eligible medical deductions because they are already paid with tax-free dollars.

If you end up not actually being able to deduct your COBRA insurance premiums paid with after tax dollars because of the 10% rule or because you don't itemize deductions this year, there's no other way to get the money into the FSA tax-free.

[dmertz]

Opus 17's answer makes sense to me.

[tlaritz]

So, you believe the $1250 I paid into my FSA, via the COBRA administrator, reduces my taxable income only if I can deduct the $1250 as part of medical expenses, the total of  which must exceed the 10% threshold.  Am I understanding you correctly, Opus17?

[Opus 17]

Correct. It's part of your COBRA premium.  That makes it a deductible medical expense.  But I can find no way to use it to reduce your W-2 box1, because that only applies to employer cafeteria plans and you weren't in one at that point.  I could be wrong but I couldn't find anything.

[tlaritz]

This is an interesting result, but a bit perplexing.  This line of reasoning would suggest that there is never an inherent benefit to contributing to a FSA thru COBRA.  Take 2 cases.  Case 1:  I spend the $1250 on medical expenses, and the $1250 does NOT flow thru the FSA.  Case 2: I contribute the $1250 to the FSA and am subsequently reimbursed from the FSA for incurred expenses.  In both cases, I can deduct the $1250 only if I exceed the 10% threshold.  So, it would appear that there is no real benefit to flowing the $1250 thru the FSA.  (In fact, flowing the $1250 thru the FSA hurts me, in that I have my money tied up instead of earning interest in an investment.  Ie, there is an opportunity cost to flowing the $1250 thru the FSA.)

Do you see what I am getting at, Opus17?  Thanks.

[Opus 17]

I agree with you, I don't know why a taxpayer would continue the FSA as part of COBRA.  There are some tricky situations if you are overspent when you are terminated (spent $2500 but only contributed $1300 so far).  And the IRS recently changed several rules around medical FSAs including the rollover/grace period rule and some rules pertaining to COBRA.  

Maybe if you are underspent at the time of termination, that money would be forfeit if you don't continue.  That would be a reason maybe.

I read several IRS announcements relating to the rule change and some accountant blogs discussing it, and I may not have caught every detail, but I didn't find any way to treat the FSA part of the COBRA payment as a pre-tax payroll deduction off your W-2.  Your W-2 is what you were paid when you were an employee, and the remaining FSA payments were made out of pocket.  It's definitely an after-tax medical expense deduction, but that has limited benefit.

[Tata_]

Being underspent in the the FSA at time of termination is the reason to continue with after-tax dollars. From SHRM's website:

If an employee does not elect COBRA upon termination, he or she cannot access the FSA funds once terminated (except for claims incurred prior to termination date), and any balances are forfeited.

[ThomasM125]

So, there are benefits to continuing coverage through COBRA, but there are not special tax benefits.

[Tata_]

Correct. If you are can spend all the money already deposited in the FSA before the effective date of the termination, no reason to continue FSA under COBRA from my perspective. There's no harm done in  continuing if 1) you believe you can spend the annual amount elected on FSA-qualified expenses (no forfeiture) and 2) you can afford to continue making the FSA deposits - it doesn't create a temporary cash flow problem for you.

[jamesL46]

The math justifying this is extraordinarily simple, and I'm shocked at how uncommon FSA continuation is especially if you are planning to use the FSA balance during a short period of time.  I expect the underutilization of extended FSA benefits under COBRA has a lot more to do with people not understanding how the rules work for it.  I personally experienced the following:

I left my job in January of a plan year  to take a break for a few months before starting another role May 1.  I had enrolled in a $2000 FSA plan and made one payroll payment of $167 as I knew I would likely be needing some pricey dental work in the early part of the year.  I continued my benefits, including FSA, through COBRA for the months February, March, and April.  Including the admin 2% I paid an additional post tax contribution of $170/month during which I accumulated more $2000 of expenses which I was reimbursed for fully.  I paid a total of $677 of mixed pre and post tax contributions and received $2000 in reimbursements during my 3 months of COBRA.  If anyone doubts the math works for extending FSA during COBRA with post tax contributions they're not trying very hard and are probably providing very poor advice on the subject.