Health-Care Accounts May Save Dollars

QUESTION: My company is offering a new type of child-care and health-care payment program that allows us to set up special accounts through the company to cover these expenses. Our company says this plan could save me money, but I don’t understand it well enough to know why. And I can’t seem to get any decent information from our employee benefits people. Can you explain what it all means? I bet there are confused people just like me out there.--R. I.

ANSWER: You bet you’re not alone. The new dependent-care and health-care reimbursement accounts aren’t easy to understand. But if you bother to figure it all out, you may very well discover that they can save you money, even beyond the tax credits that have been available for years for child-care expenses. However, as with so many other tax breaks, these plans, now offered by a variety of employers, are of most benefit to middle- and upper-income workers.

First, let’s explain how these plans work.

The reimbursement plans allow you to set aside money--before it is taxed--to pay for eligible dependent- and health-care costs. The money is put into a non-interest-bearing account maintained by your employer, and you draw against it periodically to pay your expenses. The upshot is that you are paying your medical and child care bills with pretax dollars, not after-tax ones. As a result, your overall taxable income is lowered.

For example, if you are in the 35% combined federal and state tax bracket, you keep just $65 for every $100 you earn. So, to pay medical or child-care bills of, say, $500, you would need to earn $770. However, under the reimbursement plan, you would need to earn just $500.

Under current law, a family or single head of household is allowed to set aside up to $5,000 in a child-care reimbursement account; there is no limit for medical expenses. However, be warned: The IRS imposes the “use it or lose it� approach to these accounts. If you don’t spend the money in these accounts by the end of the plan’s tax year, your employer gets to keep it. So you should only set aside an amount you are confident that you will spend.

Obviously, there is a whole set of rules defining eligible dependent-and health-care charges. For example, the rules of the child-care reimbursement program require that the taxpayer provide the name and tax identification or Social Security number of the person or program providing the care. (This requirement is designed to discourage the popular all-cash baby-sitting arrangements provided by U.S. citizens and non-citizens alike.)

Can these reimbursement programs help you? If you are a middle- or upper-income wage earner, the answer is probably yes. And they may be better for you than the popular tax credit that the government offers on child care expenses.

For example, according to one study, if your annual taxable income is more than $19,600 (for a single wage earner with one dependent) or $32,800 (for a couple with two children), you are better off taking advantage of the dependent-care reimbursement account than relying on the tax credits available for child-care expenses.

Why? If your adjusted gross income is $40,000, you are eligible for a tax credit of 20% of your child-care expenses, up to a maximum credit of $480 for one child and $960 for two or more children. So, if you have two children and spent $5,000 on child care last year, you are entitled to a credit of $960. But you could pay the entire amount from your reimbursement plan, a strategy that would result in a tax savings to you of up to $1,750, nearly twice the benefit of the tax credit program.

There is one potential downside to these programs that you might want to consider before enrolling. Money diverted to these reimbursement accounts is not subject to Social Security taxes, a fact that could lead to reduced benefits when you retire. However, if you will earn more than $48,000 a year--the maximum amount at which Social Security will be withheld anyway--your potential benefits would not likely be affected by participation in these plans.

Before making any major decisions, ask your employee benefits department for help in determining which tax programs are best for you. If you have further questions, ask your accountant or tax adviser.

If your company offers this program, it is well worth exploring. If the enrollment period for your company’s plan has already passed, as it has for many companies operating on a calendar year budget, make a note to sign up next year. October is often the month when new members are accepted.

What PLC, AG Mean in Business

Q: I often see the initials PLC after the name of a British company. What do they stand for? Also, German companies have the initials AG after their names. What do those mean?--B. R.

A: The initials PLC stand for public limited company, a type of business registration in Britain. The initials AG stand for aktiengesellschaft, which means joint stock company, a registration used in Germany, Austria, Switzerland and Liechtenstein. Both registrations are similar to the corporation designation commonly used in the United States.

Deducting Half of Household Expenses

Q: I am a widow with no mortgage who is sharing her two-bedroom house with a student. We share the entire house equally. May I deduct half of the household expenses from the rent I declare as income?--C. L.

A: By all means. The Internal Revenue Service views your situation as your renting half the house. So, declare your rental income and deduct half of your household expenses. You should have no problem.

You Must Pay In to Get Benefits

Q: I am a 63-year-old retiree who recently moved to the United States from a foreign country. I have never worked in the U.S. and have made no contributions toward Social Security. However, I am now paying U.S. income taxes on my pension and I am a permanent alien resident. Does this now make me eligible for Social Security and Medicare benefits?--M. A. W.

A: No. To qualify for Social Security and old-age medical benefits you must have contributed to the Social Security system for a minimum period of time. In your case, as a 63-year-old, you would have had to contribute to Social Security for 9 1/4 years in order to receive benefits from it.

Carla Lazzareschi cannot answer mail individually but will respond in this column to financial questions of general interest. Please do not telephone. Write to Money Talk, Business Section, Los Angeles Times, Times Mirror Square, Los Angeles, Calif. 90053.