Chapter 11: HSAs, FSAs, and the Family Credits

This post is Chapter 11 of 14 of the book Keep More of What You Earn — a plain-English guide to US taxes.

The Alvarez family is choosing health plans at open enrollment. The PPO costs $320/month in premiums with a $1,000 deductible. The high-deductible plan (HDHP) costs $140/month with a $3,500 deductible. The benefits counselor mentions three letters: H-S-A. The Alvarezes do the math, pick the HDHP, fund the HSA, and end up $3,000+ ahead in year one — while building a tax-free medical war chest for retirement.

This chapter covers the accounts and credits that pay you back now: the HSA’s triple tax advantage, the FSA’s rules, and the family credits — child, child care, education, and the mighty EITC.

The HSA: the best tax account in America

The Health Savings Account is the most tax-advantaged account in the US code — the only account that’s triple tax-free:

1. Deductible going in (above-the-line — lowers AGI)
2. Tax-free growth inside
3. Tax-free withdrawals for qualified medical expenses — at any age

Eligibility: enrolled in a qualifying high-deductible health plan (HDHP), no disqualifying coverage. For 2026: deductible ≥ $1,700 (self-only) / $3,400 (family); out-of-pocket caps $8,500/$17,000.

2026 contribution limits: $4,400 self-only, $8,750 family, plus $1,000 catch-up at 55+. Employer contributions count toward your limit. Contribute for 2026 until April 15, 2027.

The Alvarez math (22% bracket, family, $8,750): $1,925 income-tax savings + ~$669 payroll-tax savings = roughly $2,600 in first-year tax savings. Invested inside the HSA, compounding tax-free for decades. Advanced play: pay medical bills from cash now, keep receipts, reimburse yourself tax-free decades later — there’s no deadline on reimbursement.

The HDHP fear, addressed: compare total cost. The Alvarezes save $2,160 in premiums + ~$2,600 in tax savings + often an employer seed ($500–$1,000). That’s $5,000+ of advantage against a deductible that’s $2,500 higher. For healthy-to-average families, the HDHP+HSA wins walking away. Run the numbers if you have known high medical costs.

FSAs: the HSA’s use-it-or-lose-it cousin

Health FSA: pre-tax dollars (2026 limit $3,400), spend on medical costs tax-free. Use it or lose it — unspent money generally vanishes at year-end (small $680 carryover may be allowed). You generally can’t have both a general-purpose FSA and an HSA.

Dependent care FSA: $7,500 for 2026 ($3,750 MFS) for child/dependent care — usually automatic money for two-earner families: 22% marginal rate = $1,650 savings plus the 7.65% payroll-tax skip.

FSA vs. child care credit: you can’t claim the credit on FSA dollars. Rule of thumb: if your marginal rate (federal + payroll) exceeds the credit rate you’d get, use the FSA; otherwise the credit. Run both.

Education credits: $2,500 per student on the table

American Opportunity Tax Credit (AOTC): up to $2,500 per student per year (100% of first $2,000 + 25% of next $2,000). 40% refundable (up to $1,000). First four years of undergrad, half-time enrollment. Phaseout: $80,000–$90,000 single, $160,000–$180,000 MFJ (2026).

Lifetime Learning Credit (LLC): up to $2,000 per return — 20% of the first $10,000. Nonrefundable, unlimited years. Can’t claim both for the same student in the same year.

529 plans: growth and education withdrawals tax-free; for 2026, up to $20,000/student/year can cover K-12 tuition. States often add their own deduction.

Coordination tip: sometimes it’s optimal to not use 529 money for $4,000 of tuition — pay cash, claim the $2,500 AOTC, use the 529 for room and board instead.

The child credits: kids as tax planning

Child Tax Credit (2026): $2,200 per qualifying child under 17 — permanent and inflation-indexed from 2026. Partially refundable. New requirement: the child and at least one claimant must have a work-eligible SSN — ITINs don’t qualify.

Child and Dependent Care Credit (2026) — supercharged: credit rate up to 50% of $3,000 (one child) / $6,000 (two+) — maximum $1,500/$3,000. The 50% rate applies at AGI up to $15,000, phasing to 20% by $105,000 (single) / $210,000 (MFJ). Nonrefundable; claim on Form 2441 with the provider’s name, address, and tax ID.

EITC: up to $8,231 for 2026 (3+ kids) — refundable. Investment income must be under $12,200; phases out at $70,224 (MFJ, 3+ kids). ~1 in 5 eligible workers misses it. The IRS’s EITC Assistant takes ten minutes.

Adoption Credit (2026): up to $17,670 per child, with up to $5,120 refundable.

Putting it together: the family year

The Parkers, MFJ, $110,000, two kids (4 and 19 in college), $12,000 daycare, HDHP family coverage:

• HSA $8,750 → ~$1,925 income-tax + ~$669 payroll-tax savings
• Child care credit: 50% × $6,000 = $3,000
• AOTC for the freshman: $2,500
• Child Tax Credit for the 4-year-old: $2,200
• Combined: roughly $10,000+ in tax reduction from one chapter’s provisions.

None of it exotic. All of it available to any family that knows the forms exist.

The HSA after 65: the rules change

Once you enroll in Medicare, you can no longer contribute — but the account transforms: the balance keeps growing tax-free, medical withdrawals (including Medicare premiums) stay tax-free, and the 20% penalty on non-medical withdrawals disappears at 65. In your early 60s, max the HSA and don’t spend it.

Employer education benefits: the $5,250 exclusion

The first $5,250/year of employer tuition assistance is excluded from income — no tax, no forms, no phaseout. It stacks with the credits.

The child care credit’s paperwork trap

Get the provider’s name, address, and tax ID in writing before the first payment (Form W-10). Form 2441 mismatches are the credit’s #1 audit trigger, and the fix is a ten-minute conversation at hiring time.

Key takeaways

1. The HSA is triple tax-free. 2026 limits: $4,400/$8,750 (+$1,000 at 55+). Fund it, invest it, save receipts, reimburse yourself decades later.
2. Health FSAs ($3,400, $680 carryover) are use-it-or-lose-it; dependent care FSAs ($7,500) are usually automatic money — but compare against the child care credit.
3. AOTC: up to $2,500/student (40% refundable); LLC: up to $2,000/return. Coordinate with 529s and scholarships.
4. Child Tax Credit: $2,200 per child under 17 (2026). Child care credit: up to $1,500/$3,000 at a 50% rate for 2026.
5. EITC: up to $8,231 refundable — and ~20% of eligible workers miss it.
6. Stack, don’t double-dip. Run both options on shared dollars and take the winner.
7. At 65, the HSA keeps its powers — tax-free growth, tax-free medical withdrawals, no penalty on others.
8. Get the care provider’s TIN in January, not April.

Next: Chapter 12 — Self-Employment and Small Business.