In the 1960s, inflation and the skyrocketing costs of employer-sponsored health insurance were taking huge chunks out of people's paychecks. Workers now found themselves paying annual deductibles and coinsurance on their health benefit plans. Some employers refused to provide their employees with dental and vision plans [source: Lindquist].
It was a big problem for many workers. In the 1970s, the federal government introduced so-called flexible spending accounts, which allowed a person to save pretax dollars for medical expenses, child care and expenses not covered by an employer-sponsored health plan. The law allowed workers to deduct a certain percentage of pretax dollars every paycheck to go into their FSA.
FSAs are still used today. Employers generally allow their employees to choose one of two types of FSAs. One is a medical FSA, in which a worker sets aside money for copayments, and uninsured treatments, such as eye exams, glasses or over-the-counter drugs. The other FSA helps employees pay the cost of child care or the care of another dependent. An employee can save up to $2,500 for healthcare expenses and $5,000 for dependent care [sources: Bell, Discovery Benefits, Flexible Benefit Service Corporation.].
Since these contributions come out of a person's salary before the wages are taxed, a worker in the 25 percent tax bracket can save $250 in taxes if they contribute $1,000. The only problem with FSAs is that a person has to use the accumulated contributions within a certain period of time or forfeit the cash or any balance. It used to be that a person had one year to use the cash. However, in 2005, the Internal Revenue Service changed the rules, giving workers an extra 2 months and 15 days past the calendar date to use that money or lose it.
Employers also receive a tax break on their employees' FSA accounts. That's because they're not paying wage taxes on FSA contributions. As a result, their Social Security and Medicare taxes, along with their federal employment taxes, are reduced. For every $100,000 of salary that their employees put into an FSA, the company saves $7,650 in taxes.