Health FSAs: IRS Issues Guidance on New "Qualified Reservist Distributions"

• distribution of all or a portion of the balance in the account, if
  • the individual is a reservist ordered to active duty for more than 179 days (or for an indefinite period), and
  • the distribution is made on or after the date of the order but no later than the last date a reimbursement could otherwise be made under the arrangement for the plan year containing the date of the order.

Plan document requirements: The plan document must be amended to provide for QRDs before a QRD can be made.

Transitional Rule: A transitional rule is available for QRDs that are made before January 1, 2010. This rule allows the plan to be amended as late as December 31, 2009 to retroactively permit the QRDs.

Employees ordered to active duty: A QRD may be taken only on account of the employee being ordered to active duty, not any other individual being ordered (e.g., the spouse). The individual employee must be ordered to active duty for more than 179 days (or for an indefinite period) as a member of a reserve component, which is defined under 37 U.S.C. §101(24) as the:

• Army National Guard
• Army Reserve
• Navy Reserve
• Marine Corps Reserve
• Air National Guard
• Air Force Reserve
• Coast Guard Reserve or
• Reserve Corps of the Public Health Service.

The Notice did not address whether the individual must be called to active duty while an employee. Therefore, it is not clear whether a terminated employee who is called to active duty would be eligible for a QRD if the duration and other requirements are met.

Amount Available: The IRC § 125 cafeteria plan should state how the employee's health FSA balance will be determined for purposes of making a QRD. It may provide that the amount available is:

1. The entire amount elected for the health FSA for the plan year, minus reimbursements received as of the date of the QRD request,
2. The amount contributed to the health FSA for the plan year, minus reimbursements received as of the date of the QRD request, or
3. Some other amount (not exceeding the entire amount elected for the health FSA for the plan year, minus reimbursements).

Option (2) above is deemed the default election. A plan which does not indicate how the health FSA balance will be determined is deemed to have elected that approach.

The Notice cautions that the plan must permit employees to submit health FSA claims for medical expenses incurred before the date a QRD is requested and must pay or reimburse those claims. However, with regard to expenses incurred after the QRD is requested, the plan may either terminate the employee's right to submit claims, or permit the submission of claims incurred before the end of the plan year (or grace period, if applicable).

Current year health FSAs: A QRD may be made only with respect to the current plan year's health FSA. A QRD may not be made with respect to amounts attributable to a prior plan year, or to a non-health FSA.

Administration and Procedures:

• Orders are determinative: The employer must receive a copy of the individual's active duty orders before the QRD may be processed. The employer is entitled to rely on the orders and, if they state the individual is called up for at least 180 days (or for an indefinite period), the duration requirement is met -- even if the actual period of active duty turns out to be less, or is changed. If the orders are for less than 180 days but are supplemented with orders that increase the period of active duty to 180 days, the individual will qualify.
• Nondiscrimination: QRDs must be uniformly available to all participants. The QRD amounts are disregarded for purposes of the cafeteria plan nondiscrimination rules.
• Procedures: An employee can request a QRD any time beginning on the date of the orders and ending on the last day of the plan year (or grace period under Prop. Treas. Reg. § 1.125-1(e), if applicable) during which the active duty orders occurred. The employer must pay the QRD within a reasonable time, but not more than 60 days after the request was made. The plan may specify a process for requesting QRDs, and may include a limit on how many QRDs may be made with respect to an individual during the plan year.
• Taxation: A QRD is included in the gross income and wages of the employee and is subject to employment taxes. The QRD is reported as wages on Form W-2 for the year in which the QRD is paid. In reporting the QRD as wages, the distribution amount is reduced by amounts that represent return of after-tax contributions (e.g., COBRA premiums).

If you have any questions or need additional information about articles appearing in this or previous versions of Washington Bulletin, please contact: Robert Davis 202.879.3094, Elizabeth Drigotas 202.879.4985, Mary Jones 202.378.5067 Stephen LaGarde 202.879-5608, Erinn Madden 202.572.7677, Bart Massey 202.220.2104, Mark Neilio 202.378.5046, Tom Pevarnik 202.879.5314, Sandra Rolitsky 202.220.2025, Tom Veal 312.946.2595, Deborah Walker 202.879.4955.

Copyright 2008, Deloitte.

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