2. Flex Your Spending Power
Sometimes, to save money on the tax bill, you must spend money elsewhere. Many employers offer a benefit that allows people to chip away at the tax bill using money they had planned on spending anyway, such as dependent care or medical expenses.
Flexible spending plans are pre-tax plans that allow certain expenses — such as dependent care, medical expenses and health insurance — to be paid with tax-exempt dollars. Employers deduct pre-determined, tax-free amounts from paychecks and place them in an administered account that releases the funds when the expenses are incurred. And, because contributing to a flexible spending account also reduces your gross income, your taxable income becomes even lower — keeping more in your wallet.
Thompson raises two warning flags. The first is the "use it or lose it" stipulation, which comes into play if the pre-tax funds aren't used in accordance with the rules. Let's say that Mom deducts pre-tax money to pay the day-care center, but then Grandma starts to take care of the baby. Unless Grandma operates a licensed, approved day-care center and charges for the care of the baby, any pre-tax money Mom set aside for day-care is lost. Second, you can't use child care as an itemized expense. Because the tax benefit was given in the flex-spending plan, that money cannot be used as a deduction unless the amount spent exceeds what was deducted pre-tax. Other child-care expenses, such as some summer camps, would not be impacted.