From the Hotline: Transfers Between FSAs

Question: Will the IRS allow an employee to transfer money from his Dependent Care FSA into his medical FSA in the same tax year?

Answer: From our review of the IRS regulations, we don’t see a way that would allow the company to move around FSA funds from the dependent care to medical and allow either plan to retain tax-favored status. That is why there is so much discussion in the literature around ensuring that communications are clear to employees about the “use it or lose it” nature of flexible spending accounts so that they budget their expenses accordingly in order to make the best “binding benefit election” possible.

To maintain a tax-qualified status, flexible spending account plans must comply with special requirements under Internal Revenue Code Section 125. FSAs also are subject to those portions of the federal tax code that apply to the type of benefit offered such as Section 213 for health care FSAs, and Section 129 for dependent care FSAs. Health care FSAs must conform to the rules under tax code Sections 105 and 106 for the coverage and reimbursements to qualify for tax-favored treatment. We checked all of those codes, and there was no language allowing mid-year election changes (except for status and cost/coverage changes) or allowing participants to move the money between accounts.

Here are the circumstances allowing Plan sponsors to permit employees to make changes in benefit elections (each of these conditions may or may not allow a change in the FSA if the plan so allows and the change is consistent with the event – http://www.irs.gov/pub/irs-regs/td8921.pdf):

  • The cost of the employer’s health plan increases (or decreases)- health FSA
  • The cost of dependent care increases or decreases – DCA
  • The coverage under the employer’s health plan is significantly curtailed or ceases, or the addition (or elimination) of a benefit package option – health FSA
  • A change made under the plan of the spouse’s or dependent’s employer – both
  • The participant has a change in eligibility for Medicare or Medicaid – health FSA
  • The participant has a change in status (new dependent, marital status, death of a dependent, employment status, eligibility, residence, etc) – both