papogi

Employers have been working without guidance from the IRS in trying to set up 105 Medical Reimbursement Plans for some time, and have traditionally tried to allow unused amounts to carry over to subsequent years (unlike the FSA with its use-it-or-lose-it provision). The problem has always been that it is hard to keep a 105 MRP from being classified as an FSA, thereby losing their desired carryover provision. Prop Treas Reg 1.125-2 (Q7) states that an FSA can exist outside of a cafeteria plan. An FSA is a benefit plan which reimburses expenses under Section 213 and the amount available does not exceed 500 percent of the total value of the benefits (the value of the account). This means that an employee would have to have the ability to take out at least 5 times the value of the 105 MRP for it not to be classified as an FSA. This difficulty is why the new guidance on HRA's is so wonderful for those employers who want these amounts to rollover from year to year. In essense, when you set up a 105 Medical Reimbursement Plan with a use-it-or-lose-it provision, and the employee can get no more than 5 times the value of the account (normally they only get 1 times the value of the account), you just created an employer-funded FSA. There's no way around it. So, you're right, there really is no difference.

An employee's decision to forego salary reduction (effectively electing cash instead of benefits) is indeed an election related to a 125 plan, although it is an election that means that the employee is not even participating in the 125 plan. If you're trying to say that since employees can possibly use all their credits and have to go into pre-tax payroll deductions that this makes all the benefits in their entirety operate under the 125 plan, I disagree. It comes back to the employer credits used first. They simply are not operating under 125 if there is no cash option for that portion. 125 begins where benefits with no cash option end. I think that what the employer is proposing is legal, it's just that a large part of it will not be under 125 (with no cash option, these funds would not be used in the 25% Concentration Test, for example). I'm not saying that this employer doesn't have a 125 plan, they do. I'm just saying that those employees who do not have any pre-tax payroll deductions are not participating in the 125 plan. Since they, specifically, had no cash option on the benefits they elected, they are not in the 125 plan. In your second example, an employer that only uses pre-tax payroll deductions to fund benefits is operating under a 125 plan, as well. It has nothing to do with the fact that the benefits are funded entirely by the employees, it has to do with the fact that employees have a choice between salary and benefits.

The Key Employee Concentration Test only applies to those amounts being funneled through the 125 plan, and applies to all non-taxable benefits (including FSA's). Amounts being run through the 125 plan include (1) any pre-tax payroll deductions, and (2) any employee-directed flex credits provided by the employer. Basically, 125 dollars are those for which there was a cash option. Any completely employer-paid benefits for which the employee had no cash option do not need to be included in the test.

You will only pay tax on that which represents amounts above your basis in the account. Your basis consists of the amounts you have already paid tax on. You will not have to pay the tax on those dollars twice. You will use IRS Form 8606 to report the conversion, and to compute that portion which is taxable. That end figure will be entered on Form 1040, line 15b.

You're fine. You are proposing medical plans subject to HIPAA and FSA's which are not subject to HIPAA because of the fact that at least one comprehensive medical plan is being offered to employees. Your FSA's are not subject to HIPAA. You will have no HIPAA cert responsibility to the FSA. You will have a flex COBRA responsibility only for the plan year in which the termination occurs, and only for those employees who terminate and have not been reimbursed an amount equal to or greater than what the employee has contributed to the account.

The employer can go over $500 no problem as long as they also offer a comprehensive medical plan (not limited scope). I am taking it that you are pushing high-deductible plans along with employer-funded FSA's. The high-deductible plan is subject to HIPAA, so in those cases those employers are fine going over $500. The real key is to be sure that the employers are offering regular medical coverage which is subject to HIPAA. Again, it only needs to be offered. Employees don't have to elect it.

Good point. If you determine that the health FSA is exempt from HIPAA, there are two special exemptions from COBRA: 1. COBRA need not be offered after the plan year in which the termination occurs. This applies if the amount paid in would exceed the benefit. The 2% administrative fee guarantees this. 2. COBRA need not be offered at all if the employee has already been reimbursed an amount equal to or greater than the amount actually paid into the account. If the health FSA is exempt from HIPAA, and item 2 above does not apply, then flex COBRA will need to be offered for the remainder of the current plan year. All qualified beneficiaries can elect a health FSA. If you determine that the health FSA is not exempt from HIPAA, COBRA will need to be offered under the usual COBRA rules (18, 29 or 36 months). All qualified beneficiaries can elect a health FSA.

I think your reasoning is correct that there are no tax implications, but I am not certain (corporate tax law is not my specialty). Hopefully someone else can confirm...

Depends on your specific paperwork, and the wording contained therein (i.e., was everything explained). If your plan sent out printed confirmation of benefit forms showing your elections and giving a week or two to change the benefits if you notice anything wrong, you might not have much luck getting the election changed. If your plan did not send confirms, and instead only relied on each employee printing out the confirm from their web browser, you might have a case, but, again, it depends on the explanations/disclaimers contained on your documents. Courts have almost always ruled in favor of employees rather than employers in situations which are ruled "unclear."

An employee's option to salary reduce only puts the affected benefits under 125. As an extreme example, assume an employee gets the company's credits and decides to opt-out of the plan entirely. Under your client's proposal, the entire credit balance must be applied to 401(k) and/or an FSA. There is no cash option. This plan is not operating under 125, since there are no constructive receipt problems. In another example, an employee uses all of his/her credits buying coverage, and must fork over some of his/her own funds. My thinking is that these employee amounts can be put through a 125 plan to be pre-tax since there is a cash option. This doesn't erase the fact that the employer-paid portion has no cash option, so this portion cannot be going through the 125 plan.

$5000 is the federal limit, and is what most 125 plans use as their own maximum. It can't be any higher. As pax says, what employer liability? Employees are only eligible for what they have actually put into their DCSA. For this reason, other than minor and rare timing issues, there should be virtually no liability for an employer to offer DCSA's.

Yes, it is. It's all we have to go on, so I think a good faith effort to administer a 125 plan would include looking at and following rules within 1.125-2. Incidentally, you can find the provisions outlining the uniform reimbursement requirement of HCFSA's, the 12 month period of coverage rule, and the rules surrounding claims substantiation within 1.125-2. These rules are almost invariably followed, so I would hesitate calling 1.125-2 merely "proposed" when it comes to real world application (even though you are correct that they are technically only proposed regulations).

I don't think that's specifically what JJD was saying (he was looking at unused credits having to go to an FSA or a 401(k), not one then the other), but I do follow your reasoning and agree completely. The clarification is good.

Katherine is correct that Form 8606 is the one taxpayers sometimes use for IRA's. Normally, most tax filers do not need to concern themselves with 8606. Most filers can add to their IRA's each year and have no tax form to fill out each year. Form 8606 is used only in certain circumstances. See "Who Must File" on page 1: http://www.irs.gov/pub/irs-pdf/i8606.pdf

I don't see that it would help. In fact, 401(k)(2)(a) states that "a covered employee may elect to have the employer make payments as contributions to a trust under the plan on behalf of the employee, or to the employee directly in cash." The optional "cash" under 401(k) must actually be cash, and cannot be a taxable benefit (unlike 125, which treats taxable benefits as cash). I am not well versed on matters concerning 401(k), but I'm wondering if this plan design will not be kosher under 401(k). Perhaps it would be OK because we are talking about employer amounts, not true elective deferrals. Either way, I don't think it helps bring this plan into 125 compliance as far as the employer-paid portions are concerned.

Once the employer removes the cash option, there are no constructive receipt issues to bypass, so Section 125 is not required to protect the employees from the value of the employer-provided coverages. Basically, they have created a plan which only needs Section 105 (amounts received from the plan) and 106 (employer contributions to the plan) protection. If these employer-provided credits are not enough to cover the costs of the desired coverages, the employee can still pay his/her portion as an elective salary reduction under Section 125, as long as the 125 plan is in place. The only thing that is changing here is that the employer-provided credits are no longer required to be funneled through the 125 plan. The employees with elective salary reductions are the only ones participating in the Cafeteria Plan in this case. I admit I don't remember ever seeing this exact situation before, so someone else please chime in if you have more insight.

You will hear differing opinions on this point at this message board. My opinion is that experience gains (forfeitures minus losses and admin costs) go into the general assets of the employer. Theoretically, they can be used in any way the employer wishes, as long as nothing directly contradicts the small list of specifically allowable options under 1.125-2 (Q7)(B)(7).

Yes, both rules must apply for the FSA to not be subject to HIPAA. Again, as long as they offer a regular, comprehensive medical plan, they should be fine. If an FSA is subject to HIPAA, you would have to create creditable coverage certificates for terminating individuals. The creditable coverage cerificate would be useless anyway, since employers are not required to take FSA creditable coverage certificates and use them to reduce pre-ex exclusion periods. So why produce the certificate for non-exempt FSA's? You have to, but at the same time, there's no purpose to it.

The health FSA is exempt from HIPAA if both of these are true: 1. The health FSA benefit does not exceed either two times the employee’s salary reduction election or, if greater, the employee’s salary reduction election plus $500. Assume, for example, an employee puts in $600, and the employer puts in $700. The employee is eligible for $1300, but only puts in $600 ($1300 is more than twice $600). This FSA, so far, is not exempt from HIPAA, and is subject to its rules. As another example, assume an employee puts in $100, and the employer puts in $600. The employee is eligible for $700, but only puts in $100 ($700 is more than $100 plus $500). Since such a large portion of the FSA is funded by the employer, the IRS sees this more like employer-provided insurance and is subject to HIPAA. As you know, most employers’ health care FSA’s are funded entirely by employees. These are exempt from HIPAA since the IRS does not see them as employer-provided insurance. 2. The employee has other group health plan coverage for the year available from his/her employer, and the other coverage is not limited to benefits that are HIPAA excepted benefits. If the only other available coverage has limited scope benefits (exempt from HIPAA), the health FSA would not be exempt from HIPAA. So, the bottom line is that if an employer gives more than $500 to its employees for an FSA, then they just need to be sure to be offering a regular, comprehensive medical plan as well (which they are in what you are describing). The employees don't have to elect the medical coverage, it just has to be offered. Based on your information, these employer-funded FSA's will not be subject to HIPAA.

Agreed. I mentioned the non-discrimination issues in my first response to the question. As far as the legality of doing things in house, I stick to my responses, but I agree with pax that there are times when it's best to have things handled by a TPA. Actually, I work for a TPA, and I can vouch for the help they can give to employers.

This situation would fall under Treasury Regs 1.125-4©(2)(iii). The employee is going through a change in employment status which affects his dependent's eligibility with regards to a DCSA (the child is becoming eligible for the DCSA because of the change in hours).

I know of many employers who handle the FSA portion of claims processing in house. The regular health/dental/vision coverage claims processing can be handled in house as well, but I can't imagine very many situations where that part would be practical or financially advantageous.

QDROphile brought up a good point. Unlike COBRA (where the Federal rules are minimum standards), the rules under Section 125 are maximum standards. The IRS says that the situation you described above is an allowable status change. You should check the plan document in question to be sure whether or not the plan allows this as a status change (most plans adopt all allowable status changes, but are not required to). In fact, it is possible for a 125 document to be written to not allow any status changes at all.

I'm not sure exactly what you're getting at. The Cafeteria Plan (Section 125) is simply a vehicle which allows employee deductions to be taken pre-tax. There's really nothing in and of itself which needs to be "administered." There will be claims processing and reporting to be done for the underlying plans offered within the cafeteria plan. But that would be true for plans offered within or outside of a 125 plan. For the 125 plan, there's not much to do. There will be some non-discrimination testing which will need to be done, but that can be done in-house, as well. Let me know if I'm missing the aim of your question.

Check out a thread called "125 Plan Documents = ?" started around mid-July on the Cafeteria Plan board. There are some other related threads, as well. Use the search feature on the BenefitsLink home page and type "EGTRRA" or "restatement" into the search window. This may get you somewhere. Hope this helps.