FSA's - can employer invest salary reduction amounts?

[Guest Red]

It may be helpful to consider the differences in treatment of FSA contributions by the IRS and the DoL.

The IRS treats contributions as a straight salary reduction: you've voluntarily asked your employer to pay you less, in exchange for a promise of benefits of equal monetary value over the course of the plan year. By following the guidlines of Section 125, you've avoided constructive receipt, and, as far as the IRS is concerned, never got this money at all.

This is an important point: you never had the money. It's not yours, it's your employer's, because you asked for an anti-raise (a "lower"?) in exchange for non-taxable benefits. The employer can do whatever she likes with the money you decided not to be paid, since it's just part of her general assets.

The DoL, in very sharp contrast, considers FSA contributions to belong to the participants; regardless of how the IRS deals with the monies for tax purposes, the DoL requires employers to treat contributions as participant contributions. Despite the non-enforcement of the ERISA trust requirements under Technical Release 92-01, these are still plan assets (Herman v. Jackson County Hospital, e.g.), whether they are ever actually separated from the employer's general assets.

As a practical matter, without a trust, there's no tracking which particular dollar in the employer's general assets belong to which participant, so there appear to be few actual limits on what the employer can do with the money that's saved (real-world, employers often deposit an amount equal to the employee's salary reductions on a pay period by pay period basis in a checking account to cover the plan's expenses, but there's no requirement to do so). Nonetheless, if you blow all your assets and have nothing to pay back the particiapants' salary reductions, you're going to have a major problem with the DoL.

Hope this helps.

[GBurns]

Red,

I think that you are taking the Regs etc out of context when you state "By following the guidlines of Section 125, you've avoided constructive receipt, and, as far as the IRS is concerned, never got this money at all". The Regs 1.125-1 Q6say that a SRA "will have the effect of causing the amounts ...to be treated as employer contributions" and "to have such amounts contributed, as employer contributions, ...on their behalf". The Regs do not make it not be employee money it only allows treatment for purposes of section 125.

Phrases such as "the effect of causing" and "to be treated" indicate a dispensation for a stated purpose not a change in ownership. That is why you should read the wording used by the Judges in cases like Grande v. Allison where it says it is the employee's money. Note should also be taken of the wording in Phelps v. C.T. Enterprises which unlike Grande which relates directly to an FSA but still relates to employee salary reductions.

As far as limits to what the employer can do, you might want to use Phelps and its references to see some of the limits.

[Guest Red]

GBurns,

I don't disagree. My post was just to illustrate how the differing points of view by the IRS and the DoL can lead to some confusion. I can readily understand how a sponsor, reading the regs without a broader legal context, would come to the conclusion that there's no practical fiduciary obligation to treat the 125 monies as employee contributions. Section 125 is deceptively brief, and it's easy to hang more than one interpretation on the language in the Code.

Your citations are excellent; I'm holding onto them for the next time I need to argue with somebody about this issue. Thanks for the background.

[GBurns]

Add these, although the attached are related to 401(k) plans, I consider them relevant because the source is similar, namely employee salary reductions and although 401(k) plans have more specific rules, logic dictates that the treatment should be fairly similar:

http://www.401khelpcenter.com/401k/perdue_401k_deposits.html

http://www.401khelpcenter.com/mpower/feature_longday.html

[Guest grafals]

The rules pertaining to a 401(k) plan have nothing to do with a cafeteria plan or FSA because a 401(K) is a cash or deferred arrangement, while an FSA or cafeteria plan is NOT A DEFERRAL. It is an ELECTION. All contributions are EMPLOYER contributions, not EMPLOYEE contributions. Trying to make a parallel misses the basic premise of such plans.

Fiduciary standards apply because ERISA states that it is applicable to welfare benefits plans and the DOL has clarified that such plans need not be funded for it to apply.

FSA's are commonly and routinely referred to as self-insured benefits. The employer is self insuring the benefits. In fact, the code and regulations permit the benefits derived under an FSA to exceed the actual amount of salary reduction, provided the benefit does not exceed them by more than 500%. Moreover, claims up to the annual benefits limit must be paid, regardless of the amount of salary reductions that occur to the date of the claim. Thus there is no required correlation between salary reduction and benefits paid. Obviously, the salary reduction does not, therefore, provide a funding source for benefits. It is simply the vehicle by which constructive receipt is avoided, to avoid tax liability on the value of the benefit. The salary reduction agreement is the payment of a premium, not funding of a plan. The premium for the benefit (don't think of it as money, its a benefit, not a box of cash) is NOT the employee's money. It is the Employer's money (the code and the regulations are clear enough about this). The employee ELECTED (NOT DEFERRED) to give up cash, opting INSTEAD to receive an alternate benefit. VOLUMES have been written on the distinction between this election and a deferral. Thus, the contributions to a 125 plan and benefits derived through an FSA are "Employer Contributions," NOT "Employee Deferrals." Sections 105 and 106 deal with amounts paid to health plans which are self insured by the employer, not deferred by the employee. Deferrals fall under Sub D.

Constructive receipt avoidance is in fact the reason why these plans exist. The whole purpose is to avoid tax liability. If the employee constructively receives (has a vested right to) the amount of the election, then the amount and the benefit is taxable. Keep in mind that IRC Sec. 105, 106 and 125 all come under Subtitle A (Income Taxes); Chapter 1 (Normal Taxes); Sub B (Computation of Taxable Income); Part III (Items specifically excluded from gross income). Both Cafeteria Plans and FSAs are creatures created solely by the tax code. Absent those sections dealing with the excludability of the benefits from income, these plans would not exist. You could create a plan to reimburse your employees for the costs of shoes if you want. But, it won't be tax qualified, so nobody will participate. The IRS gave recognition that as long as there is no present right to receive, the employee won't have to pay tax on the amount of income otherwise used to pay premiums.

If the benefit isn't used by the employee , then premiums paid generally go to cover plan expenses, which are otherwise paid by the employer (just as with any other insurance company). Once the expenses are covered, the employer's obligation is generally met, unless the contract provides otherwise, and the employer released from liability under the plan (i.e. keeps the $). I am not aware of any ERISA plan where an employer gets to convert participant contributions to its own use at the end of the plan year. The same holds here, since the salary reduction bought coverage, the coverage was provided, and the premiums earned by the employer.

References to fungible money and tracing and plan assets are misplaced since the nature of these plans is that of an insurance contract. There is no need to track or hold or reserve the amount of salary reductions. Salary reductions are just that, a reduction in the company’s salary expense. The reduction is consideration for the company’s promise to provide FSA benefits. There is no reason why a company couldn't pay claims under an FSA with money it borrows, as long as it lives up to its end of the bargain, which is to pay claims. The contract is actually quite simple. You give up salary in the amount of X, I will reimburse you for permissible expenses in the amount of Y. X and Y may or may not be the same. If a company cannot meet its FSA obligations, that means the company is INSOLVENT. The FSA liability is a debt owed by the company. When the company can't pay its debts, it is INSOLVENT.

By their nature, funds not held in trust, remain general assets of the employer, and thus subject to the claims of general creditors. The funds backing up the employer's obligation under an FSA are the capital accounts of the company. If the company goes BK, then the participants get in line with all the other creditors. Take a look at the GL of any company and I bet you won't find an asset account containing FSA funds. You might find a CONTINGENT liability account in the amount of the potential reimbursements. But, its unfunded and contingent liabilities are off balance sheet. The cash backing up the obligation is capital. So, to answer the actual question, why wouldn't a company invest their capital?

FCDEACY, invest away!

[P.S. The Grande case had only to do with when reimbursable expenses are incurred, and the hierarchy of plan documents to be relied on by participants. The court in this unreported district court case over $1,800, concluded that information provided to Grande was vague and should be interpreted in his favor in regards to whether expenses had to be incurred or billed during the plan year in question. No new law was stated in this completely unremarkable case. The Welfare Benefits Guide 9:6 Medical Benefits (2004) states in reference to this case, "The only thing this court case should be used for is to illustrate the fact that employee communications should be clear and concise."]