JWK

Employer has 12 employees in U.S., all in one location. The employer is a wholly owned subsidiary of a corporation in Europe that employs several thousand employees. I think the controlled group rules require us to consider the employees in Europe in determining whether the employer has 20 employees, meaning that the U.S. employees are subject to COBRA. Does anyone disagree?

No question that in the termination of employment scenario, a rehired employee can make new elections upon rehire, provided that the period of severance was at least 30 days and not a "sham". This is all extrapolated from Example 6 of the temporary regs and presumes a termination of employment. My experience is that most state laws require an employee to authorize payroll withholding but do not require an employer to allow the employee to revoke that authorization at will. However, I understand there are a few states, Florida apparently being one of them, where the employee must be permitted to revoke an authorization at any time. I'd explore a couple of things. First, can an employee be required to waive the revocation right as a condition of participation in the cafeteria plan? Under this approach, employees who refuse to waive still get benefits, but have to pay with after-tax dollars. Second, if the right cannot be waived, is it permissible to allow an employee to revoke pre-tax withholding absent a recognized status change? To my knowledge, this is an uncommon use of 1.125 A-6(e) but is consistent with the intent of the drafters of the regulation. Third, assuming you can rely on 6(e), what does this mean? The employee clearly can't resume participation on a pre-tax basis but is he also precluded from participating on an after-tax basis? Can the employee pick and choose which pre-tax benefits he keeps and which he discontinues? It may be worth running this past someone at IRS.

In the situation posited by the questioner, there wasn't a termination of employment. The questioner was asking how to reconcile a state law that requires an employee to be allowed to revoke a withholding election with the federal (section 125) rule that says a revocation (without some specified intervening event) is not permitted. Your comments regarding election changes following a termination of employment are interesting, but not responsive to the initial question. Under the rule in question, 1.125-2, A-6(e), an employee CANNOT reenter the plan during the same plan year, regardless of whether the employer is operating under the proposed regs or the temporary regs. The temporary regs have no impact whatsoever on 6(e). So the new rule in the temporary regulations allowing re-entry mid-plan year is of no avail. The harder question, in my mind, is how the 6(e) exception would work in practice. How do you communicate to employees that their elections are irrevocable except for this one-time opportunity to revoke? I guess you could say that you only get one pre-tax election and after that, you can make more elections but they're all based on after-tax contributions. [This message has been edited by JWK (edited 01-31-2000).]

I assume Mr. Maldonado refers to the 1997 temporary regulations. If so, his conclusion is incorrect for two reasons. First, taxpayers can continue to rely on the proposed regulations pending issuance of further guidance from the IRS--even if the plan document has already been amended in accordance with the 1997 temporary regulations. See Announcement 98-105. So, even if the temporary regulations addressed the question raised by the questioner, my reference to the proposed regulations is valid. Second, the temporary regulations do not address the cessation of contributions basis for mid-year coverage changes. The temporary regulations modify Q&A 6© and (d) of 1.125-2. Also, subsection (f) is withdrawn. The subsection I relied on, 1.125-2, A-6(e), is NOT affected by the temporary regulations. The IRS specifically stated that taxpayers can continue to rely on the existing proposed regulations concerning matters not addressed in the temporary regulations. Therefore, subsection (e) continues to be a valid basis for allowing mid-year changes in elections.

As I understand the history of the proposed section 125 regs, the IRS tried to anticipate laws of this nature in Prop. Reg. 1.125-2, A-6(e), which states that a cafeteria plan may provide that a benefit will cease to be provided if an employee fails to make the required premium payment with respect to the benefit. Under these circumstances, the empoyee must not be allowed to make a new election for the rest of the plan year. So, in a state that prohibits an employer from locking employees into a payroll withholding election for a full year, the employer can use this section of the regs to allow the election to be revoked without disqualifying the cafeteria plan. Note, however, that the benefit can no longer be provided, so this rule would not permit an employee to decrease coverage from family coverage to self-only coverage--he/she has to drop coverage entirely. Also, as pointed out by Kirk Maldonado, the DOL has taken the position that state wage withholding laws are preempted.

I guess I would turn the question around and ask on what basis, other than section 125, can an employee redirect compensation to the purchase of a nontaxable benefit without being taxed on the compensation under the constructive receipt rules?

I don't work for a consulting firm, so I think it's okay for me to say that many employee benefits consulting firms can conduct a vendor search for you, focusing not just on cost, but risk/return and customer service. I don't think it's a good idea to focus on cost alone (nor, under ERISA anyway, would it be consistent with one's fiduciary duties).

And Carol will correct me if I'm wrong, but I believe the employer can pick and choose who gets the matching contribution to the 401(a) plan without worrying about Code nondiscrimination issues since TRA '97 repealed nondiscrimination rules for most governmental employers.

You need to define "withholding" in order to get an answer to this question. If you mean amounts withheld on a pre-tax basis from employees' pay, you are subject to the 125 rules. If you mean something else, please specify.

Thanks to all for the insightful comments. By the way, I hear that Mutual of Brooklyn has a great training program.

65 year old female has $40,000 invested in traditional IRA with a basis of $8,000. She does not need this money for expenses and does not want to take MRDs at 70.5. Assume her estate is less than the unified credit equivalent, so only concern is income tax. Can she purchase a whole life insurance policy, naming children as beneficiaries, to allow for tax-free transfer of IRA proceeds upon her death?

The election changes permitted due to significant cost or coverage changes apply to health plans only, not dependent care plans. I don't think there is anything in the section 125 regs that would allow a new election because a spouse's contributions were cut back due to a projected discrimination test failure. This is a good argument to complete the projected test before January 1, so married employees may still be able to have their spouse enroll in the spouse's employer's DCAP. Joe: I think the 55 percent test for DCAPs is easy to fail regardless of the size of the employer, simply because there are so many more NHCEs in the denominator that the average benefit for NHCEs tends to be very small. Have you found a way to exclude NHCEs from testing, other than the <21, < 1 year of service, <$25,000 statutory exclusions? [This message has been edited by JWK (edited 01-12-2000).]

I haven't been able to find the official version of this document on the IRS website. Call me paranoid, but I'm reluctant to rely on secondary sources for official notices. Does anyone have a link or cite to the official document?

I think school districts that sponsor these types of "severance" pay plans have additional problems if they are designed as described in Notice 2000-1. Because these "supplemental" benefits reduce as an employee gets older and go away entirely if a participant does not actually sever employment before reaching a certain age (typically age 62), there is a serious question of age discrimination. See Solon v. Gary Community School Corp., 1999 US App. LEXIS 13174, 23 EBC 1113 (6th Cir. 1999). ------------------

HIPAA included specific individual health insurance reforms. Blue Cross may be telling you something that is literally true (the HIPAA provisions governing group plans do not apply to individual policies), but it is NOT true that HIPAA has no impact on individual policies. There are guaranteed issue requirements and limits on pre-existing conditions. You also need to know what your state insurance statutes say. In Oregon, for example, there are limits on premiums for individual policies and there's also a state insurance pool. Analyzing your situation is beyond the scope of the message board, but I'd confirm any information you get from Blue Cross with an attorney, a knowledgeable insurance agent in your state, or your state's insurance department before taking any action.

The summary of material reductions is one disclosure obligation. I'm not sure it's the only one. I think there may be a general fiduciary duty under ERISA to announce the termination of the health plan. Also, at least in the 9th Circuit, there may be a fiduciary duty to announce the possible termination of the health plan as soon as the termination is under "serious consideration." Talk to your legal advisor on the requirements in your jurisidiction. Don't forget to send certificates of creditable coverage. These will be very important for employees who have to go out in the individual market to purchase coverage. I also think it's appropriate to tell employees that they need to act quickly to apply for replacement coverage to avoid a 63 day break, which can cause them to lose guaranteed issue and subject them to preexisting condition exclusions. Finally, is the plan funded through any kind of a trust? If so, you need to consider the excise tax under code section 4976 if there's a reversion to the employer. There's a lot to think about in terminating a health plan--please talk to your professional advisors before you embark on this course of action. ------------------

There was recently a thread on this topic on this message board. Short answer is this is not a good idea for several reasons, including possible violations of the Section 125 regs, COBRA, and state wage withholding laws. [This message has been edited by JWK (edited 01-06-2000).]

I'm in agreement with MWeddell based on my reading of the regs. I wonder whether anyone has dealt with electronic delivery of prospectuses? Is there any guidance out there?

As you may know, since you're asking this question, in an ideal world, those elections would have been made before January 1,2000. According to Treas. Reg. 1.125-1, A-15, elections should be made before the first day of the plan year. If (as appears from your question) this is the first year of the plan, I'd be tempted to have a short first plan year, running from 2/1/00 to 12/31/00, and have the contributions for January coverage made on an after-tax basis. (Don't know if this is practical--I'd be interested in hearing comments from others on this.) If the above solution doesn't work, I'd be more comfortable implementing the elections on 2/1, because it's after the last day of the initial enrollment period. So the January contributions would still be after-tax, but I guess you'd use a 1/1/ to 12/31 plan year on your 5500. [This message has been edited by JWK (edited 12-23-1999).]

I think most employers try to have one open enrollment for all welfare benefits. An exception I have seen is for nonprofit organizations--they frequently operate on a June 30 fiscal year, so they'll operate insured plans on a July 1 to June 30 plan year. However, they operate flexible spending accounts on a calendar year because it seems to be easier for participants, especially on a dependent care reimbursement plan. In that limited situation, I've seen different enrollment periods. Transitioning to a single enrollment period can be tricky because it requires working with short plan years and coordinating with insurers. But once you get there, I think you'll be glad you did. ------------------

This isn't really an IRS decision; they are bound by the statute. Health care expenses generally can be reimbursed through an FSA if the expenses would be deductible under section 213 of the Code. Section 213 limits deductibility of medicine and drugs to "prescribed drugs". Prescribed drugs are those drugs prescribed by a "physician" as defined in 42 USC 1395x®. A physician in 42 USC 1395x® means: 1. a doctor of medicine or osteopathy 2. a doctor of dental surgery or dental medicine 3. a podiatrist 4. an optometrist 5. a chiropractor. A naturopath is not on the list. Therefore, drugs/remedies prescribed by a naturopath are not "prescribed drugs" under section 213 and are not eligible for reimbursement through a health FSA. Note, however, that medical care provided by a naturopath for a specific condition or illness may be eligible for reimbursement even though drugs/remedies are not.

Lisa is correct. We advise against the final paycheck arrangement, but some employers do use it.

No, if you elect COBRA, you CAN submit claims incurred after 6/30/2000. That's the reason for electing COBRA, so you can get "stranded" contributions out of the FSA that you would otherwise forfeit. Note that in your example, there would be no advantage to electing COBRA because the participant has received $1500 in benefits and paid only $1000 in "premium." So the participant can quit while he/she is ahead, which is where the employer risk element comes in. Also, note that the posts in this thread have referred to the rules that usually apply to health FSAs--you need to also take a look at the plan document to confirm that this is how the actual plan is operated. For example, some health FSAs purport to require the participant to contribute the entire remaining election amount for the year out of the last paycheck. Many people believe provisions of this type violate COBRA and state payroll withholding rules (if applicable), but there are arguments on both sides. I'd want to know if the plan had such a provision and whether and how it was enforced before electing to participate. ------------------

It seems to me that you'd want to look at an eligible 457 plan to avoid the substantial risk of forfeiture rules under 457(f). The employer could contribute up to $8000 per year (indexed) to the eligible 457 plan. The plan probably can't be funded (depending on the nature of the governmental entity you're dealing with) but doesn't have to worry about nondiscrimination. You do need to look out for the coordination rules in 457© if this exec is contributing to the 403(B) plan. As an aside, are you sure that this is an eligible 403(B) employer, i.e., are you sure they are a 501©(3)?

I did a small survey among benefits professionals I know, and they all stated that partial years of service must be credited for benefit accrual purposes under the elapsed time method. Is there a consensus that this is correct?