Termination of a dependent care FSA

[Carol V. Calhoun]

This one seems like there should be a simple answer, but I'm not finding it. What happens if an employer terminates a dependent care FSA in mid-year? For example, suppose the employee is putting aside $400 a month. The employer terminates the plan June 30, so the employee has put away $2,400. However, the employee has received no reimbursements yet, having expected to use the whole amount only in the last six months of the year. (For example, the employee's wife is home and taking care of the baby for the first six months of the year, but the money was put aside to cover child care for the last six months.)

Can the employer simply cut the program off, with the employee losing the $2,400? May the employer stop future contributions, but still pay out the $2,400 already contributed? Or must the employer continue the plan until the end of the year, so that the employee can contribute the full $4,800?

And what if the employer ceases to exist? In that case, options 2 and 3 are out of the question. Does the employee just lose the money?

[Belgarath]

Would this possibly be considered an "experience gain" under 1.125-5(o)(1)? If so, it seems to provide that the employer can retain the money. However, I'd be a little surprised if the plan would be drafted this way (for participant contributions) even if it is permissible. Seems like it would more likely be returned to the participants on a "reasonable and uniform basis" as also provided for in that same section.

[Carol V. Calhoun]

Yeah, my concern is that even if it's returned to participants on a "reasonable and uniform basis," the guy who put in the $2,400 loses at least most of it (since it would be divided among all the employees, not just the specific one who made the contribution). Since all of the money was employee money, it doesn't seem right that an employee could lose it due to the employer's decision to terminate. But I'm not seeing a lot of other options.

[Chaz]

I responded on the cafeteria plan board but see this here and it looks like you have already at least considered some of my thoughts. Off the top of my head, though, I believe that the IRS specifically prohibits allocating forfeitures based on experience, which you would be doing with respect to the guy in your example if you give him a non-uniform distribution.