Refund dependent care FSA balance?

[LRDG]

The example in prop reg 1.125-1, Q-18, refers to a plan that operates in a manner that allows DCFSA funds to be used for other benefits or refunded without respect to forfeiture requirements. IRS issued a moriterium on Sec. 125s. The moratorium was lifted when Proposed regs under 1.125-1 were issued. Over time there have been refindments to Sec. 125 based on administrator's experiences not anticipated by IRS when Sec. 125 was written and adopted.

IRC, 2002FED 7320, Sec. 125, CAFETERIA PLAN

§1.125-4 Permitted election changes.—

Example 5. (i) Employee A is married to Employee B and they have one child, C. Employee A’s employer, M, maintains a calendar year cafeteria plan that allows employees to elect coverage under a dependent care FSA. Child C attends X’s on site child care center at an annual cost of $3,000. Prior to the beginning of the year, A elects salary reduction contributions of $3,000 during the year to fund coverage under the dependent care FSA for up to $3,000 of reimbursements for the year. Employee A now wants to revoke A’s election of coverage under the dependent care FSA, because A has found a new child care provider.

(ii) The availability of dependent care services from the new child care provider (whether the new provider is a household employee or family member of A or B or a person who is independent of A and B) is a significant change in coverage similar to a benefit package option becoming available. Because the FSA is a dependent care FSA rather than a health FSA, the coverage rules of this section apply and M’s cafeteria plan may permit A to elect to revoke A’s previous election of coverage under the dependent care FSA, and make a corresponding new election to reflect the cost of the new child care provider.

Example 6. (i) Employee D is married to Employee E and they have one child, F. Employee D’s employer, N, maintains a calendar year cafeteria plan that allows employees to elect coverage under a dependent care FSA. Child F is cared for by Y, D’s household employee, who provides child care services five days a week from 9 a.m.to 6 p.m. at an annual cost in excess of $5,000. Prior to the beginning of the year, D elects salary reduction contributions of $5,000 during the year to fund coverage under the dependent care FSA for up to $5,000 of reimbursements for the year. During the year, F begins school and, as a result, Y’s regular hours of work are changed to five days a week from 3 p.m. to 6 p.m. Employee D now wants to revoke D’s election under the dependent care FSA, and make a new election under the dependent care FSA to an annual cost of $4,000 to reflect a reduced cost of child care due to Y’s reduced hours.

(ii) The change in the number of hours of work performed by Y is a change in coverage. Thus, N’s cafeteria plan may permit D to reduce D’s previous election under the dependent care FSA to $4,000.

Example 7. (i) Employee G is married to Employee H and they have one child, J. Employee G’s employer, O, maintains a calendar year cafeteria plan that allows employees to elect coverage under a dependent care FSA. Child J is cared for by Z, G’s household employee, who is not a relative of G and who provides child care services at an annual cost of $4,000. Prior to the beginning of the year, G elects salary reduction contributions of $4,000 during the year to fund coverage under the dependent care FSA for up to $4,000 of reimbursements for the year. During the year, G raises Z’s salary. Employee G now wants to revoke G’s election under the dependent care FSA, and make a new election under the dependent care FSA to an annual amount of $4,500 to reflect the raise.

(ii) The raise in Z’s salary is a significant increase in cost under paragraph (f)(2)(ii) of this section, and an increase in election to reflect the raise corresponds with that change in status. Thus, O’s cafeteria plan may permit G to elect to increase G’s election under the dependent care FSA.

and

(iv) Application to dependent care. This paragraph (f)(2) applies in the case of a dependent care assistance plan only if the cost change is imposed by a dependent care provider who is not a relative of the

employee. For this purpose, a relative is an individual who is related as described in section 152(a)(1) through (8), incorporating the rules of section 152(b)(1) and (2).

Example 9. (i) Employee A has one child, B. Employee A’s employer, X, maintains a calendar year cafeteria plan that allows employees to elect coverage under a dependent care FSA. Prior to the beginning of the calendar year, A elects salary reduction contributions of $4,000 during the year to fund coverage under the dependent care FSA for up to $4,000 of reimbursements for the year. During the year, B reaches the age of 13, and A wants to cancel coverage under the dependent care FSA.

(ii) When B turns 13, B ceases to satisfy the definition of qualifying individual under section 21(b)(1) of the Internal Revenue Code. Accordingly, B’s attainment of age 13 is a change in status under paragraph ©(2)(iv) of this section that affects A’s employment-related expenses as defined in section 21(b)(2). Therefore, A may make a corresponding change under X’s cafeteria plan to cancel coverage under the dependent care FSA.

The events involving the moratorium is an interesting story with relevent insight to how regs. and plans have evolved, IRS response to requests from administrators and benefits lobbying organizations.