Question

Problem 11-19 (LO. 2) Rosa's employer has instituted a flexible benefits program. Rosa will use the plan to pay for her daughter's dental expenses and other medical expenses that are not covered by health insurance. Rosa is in the 24% marginal tax bracket and estimates that the medical and dental expenses not covered by health insurance will be within the range of $4,000 to $5,000. Her employer's plan permits her to set aside as much as $5,000 in the flexible benefits account. Rosa does not itemize her deductions. a. Rosa puts $4,000 in her flexible benefits account, and her actual expenses are $5,000. What is her cost of underestimating the expenses? $ b. Rosa puts $5,000 in her flexible benefits account, and her actual expenses are only $4,000. What is her cost of overestimating her expenses? (Assume this is a "use or lose" plan).

Answer 1

Answer:

a. If Rosa underestimates the account by $1000, the cost of error is her marginal tax rate times the underestimated fund. So, we calculate it as (1000 x 28%) = $280.

b. If Rosa overestimates her account by $1000. the cost if error can be calculated as  [(1- 28%) x $1000] = $720.