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Refund dependent care FSA balance?


Guest crs
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We have an employee who stopped contributing to his dependent care FSA because of a permitted change in election. However, he has a balance in his account but will not have any dependent care expenses for the rest of the year. Can we refund him the balance?

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When you say "rest of the year," what do you mean? If you mean expenses incurred after cessation of participation, they would not be reimburseable in any event. The participant can only be reimbursed for dependent care expenses incurred prior to cessation of participation. The participant will come up short only if he/she was "pre-funding" his/her dependent care account.

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The employee is ceasing his participation in the dependent care FSA, not the cafeteria plan. Unfortunately he did pre-fund the dependent care FSA but it appears that he is out of luck. Thanks for the responses.

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Guest Kristine

You cannot pre fund the Dependent Care account.

When you say "rest of the year," what do you mean? If you mean expenses incurred after cessation of participation, they would not be reimburseable in any event. The participant can only be reimbursed for dependent care expenses incurred prior to cessation of participation. The participant will come up short only if he/she was "pre-funding" his/her dependent care account.
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By "pre-fund," I mean that the bulk of the employee's dependent care expenses were going to fall at the end of the year, and therefore, while the same amount has been taken out of his comp over the course of the year, he intended to submit requests for the larger reimbursements later in the year. As a result of a change in statutus, he now has a balance in his account.

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If there is a qualifying event/status change there is an opportunity for the participant to change their annual election, which usually results in a recalculation/adjustment to the payroll deductions previously credited to the DC account balance as of the effective date of the qualifying event.

Example: The annual elected amount $4000, or $333.33 per month. $1999.99 funded over 6 mos. into the DC account. If the qualifying event results in $2000 annual election, $166.66 payroll deduction over 12 mos, resulting in $999.99 funded through the date of the qualifying event that occured in the 6th month of the plan year.

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Kristine

What do you mean by "pre-funding"?

To me, and it seem the others also, all DCAP in an FSA is "pre-funded. The employee " pre-funds" by making salary reduction contributions BEFORE submitting expenses. An account balance is created and exists before expenses are even incurred. That is what I understand when someone says that the employee "pre-funds".

What do you mean?

jpod

Why does ceasing elective contributions mean a cessation of participation? I always thought that it was possible to participate in either or both the FSA and DCAP without making contributions.

Further, If ceasing contributions equates with ceasing participation and that causes the situation where "The participant can only be reimbursed for dependent care expenses incurred prior to cessation of participation.", How do you reconcile that logic with COBRA. The employee who elects COBRA certainly has ceased elective contributions, is no longer an employee, yet gets benefits from the account that existed prior to cessation of employment and contribution. The COBRA covered employee is a participant yet ceased contributions. What is different in this scenario that leads to your position?

George D. Burns

Cost Reduction Strategies

Burns and Associates, Inc

www.costreductionstrategies.com(under construction)

www.employeebenefitsstrategies.com(under construction)

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If the new election amount resulted in overfunding based on the original election to the DC-FSA, a post-tax refund can be made to the participant.

IRS regs with respect to qualifying events allow participants to change annual elections. As with any mid-year qualifying election change, the event and the election change must be consistant.

The participants plan year changes from January-December, assuming it's calander plan year. The participant's new plan year will begin in January and end on the date that coincides with the effective date of the qualifying event.

It's possible for the participant to change their annual election to equal the amount reimbursed during the period of coverage and remain compliant with IRS regs.

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LDRG: I am not fully grasping your point, but I do know enough to know that the IRS regulations certainly do not allow a refund of previously made contributions, whether the refund is pre-tax or post-tax. The only way you can get your money back is through reimbursement of qualifying expenses incurred while a participant in the DCAP.

GBurns: I don't know how to respond other than to say that the only reason a medical fsa participant would elect COBRA in the first place is because he/she has left money on the table and needs to continue to participate in order to get back all the money he/she has in the fsa.

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Sorry but i disagree. The DC-FSA account balance must be adjusted based on the new election.

I'm not suggesting that forfeiture can be avoided. but forfeiture is not an issue if after making payroll deduction adjustments based on the new election amount the participant's original election resulted in 'overfunding' the DC-FSA.

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I'll keep an open mind, but this is news to me. Is anyone reading this interested in explaining to me what provisions of the proposed and final 125 regs. support what LRDG is suggesting? To me this sound very similar to the pre-84 ZEBRAs that prompted the original proposed regulations.

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jpod, this is NOT a zero balance issue. It is NOT a FORFEITURE issue. It is an accounting issue based on an eligible election change. Nothing in the IRS regs prevent FSA account adjustments and post tax participant refunds becuse of eligible election changes or administrative error, provided an amount otherwise meeting the Forfeiture requirements is not refunded.

EXAMPLE: assume employee X's DC-FSA annual election was $1200 for January 1st thru December 31st plan year, with payroll deduction of $100 per month. In July X has funded/deposited $600 into hir DC-FSA.

Employee X makes a qualifying annual election change reducing hir election to $300.00, funded by payroll deduction of $50 monthly beginning January 1st thru July 31st, at which time X will no longer participate.

Original Election $1200, *$600 funded to X's DC-FSA based on $100 monthly from January thru July*

New Election $ 300, *$300 funded to X's DC-FSA based on $ 50 monthly x 6 mos = $300.00 from January thru July*.

$600 funded from January-July at $100 monthly

-$300 funded from January-July at $ 50 monthly

-------

$300 = the extent to which the account was overfunded, and eligible to be refunded post-tax to X.

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Guest Pensions in Paradise

I'm sorry, where does it say in the regs that a participant can make a retroactive change?

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Pensions in Paradise: Why do you consider the change to be retroactive?

The change, according to the OP, was as a result of a "permitted change in election".

**************

I had not come across this situation before and although my gut feeling says that there should be no refund, LRDG does cause me to think that it could be done.

Now that I think about it, there is nothing that says that an election has to be a positive amount, So what happens if that is what the employee elects, e.g. -$50 per pay. Yes that is a minus sign. What stops this from being done?

Looking at Treas Regs 1.125-4 I see examples that , on the face, seem to allow refunds. For example 1.125-4© 4) Example 9 allows cancellation of the FSA election. What now happens to the account balance? There will be no claims to reimburse. Then there is 1.125(f) 5) Example 5 which allows the employee to revoke a previous election. If you revoke, you are annuling the election, it never happened. So doesn't that mean that the account reverts to the status it was in before and without the now revoked election? How do you do this without refunding the amount in the account?

I would say that LRDG's examples are quite plausible, although I think that a literal reading of the examples in the Treas Regs gives easier solutions.

George D. Burns

Cost Reduction Strategies

Burns and Associates, Inc

www.costreductionstrategies.com(under construction)

www.employeebenefitsstrategies.com(under construction)

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Guest Pensions in Paradise

All I can say is read the regs carefully. Both examples you cite do not support your position if you read the entire regs. I'll let you figure it out.

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GBurns, "I had not come across this situation before". No offence intended, but I find that hard to believe.

" LRDG does cause me to think that it could be done." Seems you've given this some thought. I'm flattered that you even consider the possibility that a qualified election change coule be for an amount less than the original election amount. (Not flaming. On second thought, maybe a not-to-hostile-flame. a friendly flame, but only because I like your posts and use of reference material.)

the number of similar circumstances i've encountered, researched and confirmed with bureau chief of the IRS Division of Employee Benefits and Tax Exempt Organizations. The most recent discussion with IRS about a "qualified post tax refund"? took place more than a decade ago at a Sec.125 conference in DC. The IRS official authored Sec.125. I think it is difficult to argue the issue based on my source.

If my post contained professional opinion or speculation, I would indicate that it was.

Pensions in Paradise, i couldn't agree with you more.

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Kristine

Why does ceasing elective contributions mean a cessation of participation? I always thought that it was possible to participate in either or both the FSA and DCAP without making contributions.

Further, If ceasing contributions equates with ceasing participation and that causes the situation where "The participant can only be reimbursed for dependent care expenses incurred prior to cessation of participation.", How do you reconcile that logic with COBRA. The employee who elects COBRA certainly has ceased elective contributions, is no longer an employee, yet gets benefits from the account that existed prior to cessation of employment and contribution. The COBRA covered employee is a participant yet ceased contributions. What is different in this scenario that leads to your position?

In an FSA, a terminated participant must be making contributions thru COBRA to be participant. If the contributions cease, participation ceases.

COBRA participation in an FSA only makes sense when no covered services had been incurred while still employed - "money left on the table" as someone else put it

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I agree that you can't retroactively change elections. That flies in the face of risk shifting. And, in the example, if you could change it retroactively, what would happen if the person had already spent $600? Don't answer b/c there's no way you can retroactively change an election.

However, it is possible to pre-fund a benefit. I don't know if it's limited to the health FSA or not, but one could accelerate contributions. The regulations provide that to the extent you accelerate payments, then the individual is entitled to a refund if coverage ceases and there has been an overpayment.

This was a game employers played to reduce the risk of loss. For example, if an employee elected an annual benefit of $1,200 in a health FSA, the employer could take out $1,200 in Jan.; or $600 for Jan. and Feb., etc. The regs prevent this game b/c if $1,200 is taken out in Jan. and the employee stops coverage in the health FSA in Feb., then the employee is entitled to a refund of $1,100. It's similar to a refund of premiums. I suppose in a dependent care program I could do the same thing - here it would be the employee deciding to accelerate it b/c the employer has no risk of loss. But, if 100 is taken out every month and the employee ceases coverage in July w/out incurring expenses, the $600 that had already been contributed is forfeited. There's no way around that.

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Rob R, there are fundemental IRS compliance problems with statements in your reply.

There is no risk shifting in a DC-FSA, (or COBRA). DC-FSA claims are only paid up to the available balance vs. Medical FSA claims which must be paid up to the annual elected amount, involving risk shifting.

When making any FSA election change, the account balance, after adjustments, is reduced by prior claims. Again, it's basic accounting practices that do not violate IRS compliance.

Following the example i used previously:

$600 funded from January-July at $100 monthly

-$300 funded from January-July at $ 50 monthly

-------

$300 = the extent to which the account was overfunded, and eligible to be refunded post-tax to X, less claims previously paid. However, because DC-FSAs only reimburse up to the available balance, off-setting previously paid claims would be uncommon.

After all DC-FSA adjustments are made if there's a negative balance, previously paid claims that exceed the NEW account balance would be denied as ineligible because they exceed the elected amount. The over payment, plus tax, must be paid back to the plan by the participant.

The facts and circumstances outlined by cr? are that the original DC election included expenses intended to be spent later in the plan year. The election change is IRS Eligible based on facts and circumstances. For example, the dependent attends before school (7a-8a) and after school (3p-6p) day care, totaling 4hrs. per day, at $45.00 per week. During the summer months day care is, for instance 7am-6pm, 11 hrs. per day, costing $135 weekly.

The day care provider decides they will not be offering summer day care services for any number of business reasons. For example, registeration for the summer DC program was lower than expected. I've seen this in school based day care programs.

The original $1200 election was based on $900 summer camp expenses that for reasons beyond the control of the DC participant, will not be incured and qualifies for an election change. No risk-shifting, no COBRA.

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I used the health FSA as an example of where pre-funding had been attempted. While there is no risk of loss to an employer in a dependent care FSA (and thus no need for the employer to play the pre-funding game), there is a risk of loss to the participant - which is exactly the issue at hand.

If I made an election based on an erroneous assumption, that's my loss - thus there is a risk of loss to the participant, but not to the employer.

It probably is not worthwhile to continue the debate. Your position is inconsistent with the change in status regs where it states the new election is for the remaining portion of the period (see below from the regs).

© Changes in status -- (1) In general -- (i) Change in status rule. A cafeteria plan may permit an employee to revoke an election during a period of coverage with respect to a qualified benefits plan to which this paragraph © applies and make a new election for the remaining portion of the period (referred to in this section as an election change) if, under the facts and circumstances --

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Risk Shifting as written in the IRS regs does not refer to shifting risk of loss to participants. Risk shifting only applies to a plan sponsors regulatory requirement to apply the uniform coverage rule to a medical FSA.

"Uniform coverage' meaning Medical FSAs could no longer reimburse Medical FSA claims based on the available balance, but must reimburse Medical FSA claims based on participants annual elections, irrespective of available balance. Risk Shifting to the plan sponsor/employer is the consequence of the uniform coverage rule.

The participants risk of forfeiting unused Medical or DC funds have not changed since the beginning of Sec. 125 plans and it's inclusion in the IRS code.

The term 'Pre-funding' (not mine), with respect to FSAs can be interperted to mean that funds reimbursed from a FSA total less than the balance that has accumulated via regular payroll deductions.

I have no first hand experience with FSA plans that require participants to 'pre-fund' spending accounts. I have heard of FSA plans designed by plan sponsors that require spending accounts to be 'pre-funded', but I personally am not an advocate of that type of arrangement, find it is administratively more complicated, and that in practice it serves no purpose.

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LRDG: I dont understand how your position on reimbursement is consistent with prop reg 1.125-1, Q-18 which provides that " a program under which participants receive reimbursements of dependent care expenses up to a specified amount and are entitled to receive, in the form of any other taxable or non taxable benefits, any portion of the specified amount not used for reimbursement is to be treated as a single benefit that is not a dependent care assistance progam within the scope of section 129. .... If the participant elects the right to receive reimbursements of dependent care expenses, the reimbursement will not be treated as made under a dependent care assistance program if, after the periood of coverage has commenced, the participant has the right to revoke his election of this benefit and instead to receive the cash or if, under the terms of the program itself , the participant is entitled to receive, in the form of cash (e.g. a routine payment of salary) or any other benerit, any amount not reimbursed for dependent care provided during the period of coverage. "

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