papogi

The IRS has been somewhat wishy-washy on the subject. For instance, they have said that an employee can drop a DCFSA if they "elected it by mistake" and didn't even have a qualifying child. Theoretically, someone could elect the account knowing full well that they don't have a qualifying child just for purposes of reducing taxable income, thereby making them eligible for some other tax break which may be valuable to them. Modified adjusted gross income calculations usually put these sorts of deductions back into the income, but there's probably something out there that this would work for. If they then realize that they no longer need that other tax break and wish to drop the DCFSA, they could go in claiming this IRS exception. Either way, the case in question is not exactly like the one that the IRS outlined as a possible correction, so I agree with Mary on this.

Based on the regs in 125-4, this is a qualifying event which would allow you to drop the DCFSA. I would caution again that the time frame specified in the 125 plan doc (usually 31 days, but not always) should be adhered to. The reason that this is important is because the IRS only allows election changes on account of and corresponding to family status changes. They don't want employees to use "forgetting" as areason to add or drop accounts. I realize the circumstances surrounding your case, and they might be enough to stand up in the face of a rare IRS audit. Depending on specific wording in your employer's flex plan document, they may not be obligated to let you frop the account. Truth is, the day that your wife dropped from college and began awaiting a spot, you no longer qualified for the account and you should have notified HR to stop the account. If and when your wife went back to school, then the account could have started up again.

Good point concerning the 20% safe harbor threshold that I usually use, mroberts. The 20% increase has to be to the employee. Whatever the total premium (EE and ER contribution), the EE portion should increase at least 20% to be safely labelled significant.

Based on my understanding, yes. Even though employee contributions are not considered plan assets for some purposes, that won't help here. An SAR is required.

Your reply helped me out, so I can clarify my answer. Often, people talk about employee contributions and how these should be distributed so as to remain non-discriminatory. Your follow up lets me know better what you were looking for. 125© says that a flex plan cannot discriminate in favor of highly compensated participants with regard to contributions and benefits. In this case, contributions are employer contributions to non-taxable benefits and employer contributions to total benefits (this would include the premiums to Blue Cross). The employee contributions are not considered employer contributions. Even though 125 essentially turns employee payroll deductions into employer contributions, my understanding is that these funds are still employee contributions for non-discrimination purposes, and should be subtracted from the employer contributions. Actually, if the percentage of premium allocable to employee pre-tax contributions is the same for each coverage level, then the calculation comes out the same whether you subtract the employee contributions or not. Since your case involves a flat $40 from each person, it will affect calculations. Again, my understanding is that this $40 needs to be subtracted from the employer's contribution. Concerning benefits, each participant must have an equal opportunity to select non-taxable benefits, and the actual selection of benefits cannot be discriminatory, meaning highly compensated participants must not select non-taxable benefits significantly more than other participants. There is very little IRS guidance on the specifics of the benefits test. You should be safe as long as non-taxable benefits are offered equally to all participants, and the plan passes eligibility tests. A plan is really not supposed to discriminate in favor of highly compensated participants at any time during the year. If the plan is discriminatory, all highly compensated participants will suffer tax consequences. The non-highly compensated participants are still protected.

One good place for IRS regs is www.125plan.com. You can find most of the 125 regs and subsequent updates. Also, www.changeofstatus.com provides a decent flow chart for 125 plan election changes. A couple of their opinions are debateable, I think, but it's very useful. It's true that the IRS does not specify a time frame for all status change election changes. In order to comply with the consistency rules, a 31 day window is typically written into each 125 plan. It doesn't have to be 31 days, but it does seem to be the industry standard. They will have to check their document.

Contributions are supposed to be the employees' pre-tax payroll deductions (i.e., monies that fund the plan). Benefits are supposed to mean the payouts from the plan. What a strange plan design. They should simply raise the pre-tax payroll deductions attached to each plan and coverage level a set percentage. This will still give the employer the funds, but it will prevent the single coverage employees from footing a greater percentage of claims than the family coverage employees.

Good point. That is correct. FSA checks need to be in the employer's name for the plan to stay "unfunded".

A POP is simply a basic 125 plan which allows employee contributions to qualified benefits to be handled pre-tax. It is just a funding mechanism for the underlying welfare plans.

Actually, ERISA Technical Release 92-01 allows pre-tax employee contributions to FSA's while allowing the plan to remain "unfunded." Since you have fewer than 100 participants and 92-01 keeps the plan unfunded, you don't have to file 5500.

In most cases, a Roth IRA makes more sense than a Traditional IRA. The simplicity of tax-free withdrawals is appealling, as well. Since this money is for retirement, which is a long way off for you, it is usually advisable to take some risk and put your money in a good mutual fund which invests entirely in stocks (equities). Stocks don't yield an interest rate like CD's do. Instead, they pay dividends and their share price goes up over time (at least, that's how things work long-term, even though the past two years have been rough). The potential for growth in stocks outweighs the risk of loss when you take a long-term view. A good place to start is Vanguard. Their website will give you information about their various funds, and a way to order the forms needed to set up the account. Personally, I would recommend a low cost diversified stock fund like the Vanguard Total Stock Market Index Fund. This fund mirrors the entire market, and is less volatile than less diversified funds. You can take out amounts that represent your annual contributions from a Roth IRA. This is not recommended, however. Most features of Roth IRA's shine when you earmark the money for retirement. If there is an expenditure in your mind that you know you will have to pay in the near future, the Roth IRA is not the way to pay for that. Since you can only take your contributions out with no tax or penalty, you eliminate any chance for growth for those dollars. Money that you know you will need to spend soon should be in short-term CD's or in a money market fund. You can get the money easily, and you can get a little growth in the meantime.

Doesn't sound like it. The IRS does not require a Form 5500/Schedule F, and ERISA does not require one if you have fewer than 100 participants and are unfunded (no employee contributions).

This is an interesting one. There does not seem to be any guidance anywhere in the 125 regs to help. To answer your first question, my thinking is that laid off employees can be treated differently than terminated employees. Second one, extending eligibility without employee contributions does seem to be OK. For example, under FMLA, the IRS says that an employer can require an employee pay his/her share of premium while out on leave, but that the employer can waive this requirement as long as this is done on a non-discriminatory basis. Even though some employees may have only elected $200 for the year and others may have elected $1500, it seems OK to the IRS that the company can pay the premiums for these employees even though the bottom line benefit is different for each different election. This seems odd to me, since employer-funded FSA's normally should be funded as a flat amount for everyone, or based on a percentage of compensation. The FMLA rules infer that the IRS does not mind this disparity, however, so one could apply this reasoning to paying premiums for laid off employees. Again, I see nothing that specifically outlaws this idea, but the lack of guidance makes this somewhat risky.

The guidance that the IRS gives concerning forfeitures (experince gains) can be found in 1.125-2 Q-7(B)(7). It states that forfeitures may be used to reduce administrative costs, reduce required premiums for the following year, or returned to the premium payers as premium refunds. Like most of the guidance in 125, the IRS uses the word "may." This means you don't have to return the forfeitures to the participants, but if you do, there is the guidance. Nowhere does it say that you "must" use one of the three possible outlets. If your 125 plan doc does not otherwise specify how experience gains are to be used, the funds go into the general assets of the company, and can be used however you wish.

Yes, you can take out amounts that represent regular, yearly contributions. Even though the market is down, this won't last forever. Your money has to be in the market to participate in the eventual turnaround, so think carefully before removing the money. Remember, when you go to replenish the account some day, you will have to deal with the annual maximums each year. Depending how much you take out, it could take several years of contributions and missed earnings before you are even back to where you once were.

This should be reimbursable in the old year, the year the hearing aids were fitted and billed. Reimbursing from the next year is not allowed because it would make it too easy to predict expenses. For example, assume an employee and spouse went in for hearing aids in December, although they will not receive them until January (they have a calendar year HCFSA). They incur a total of $700 in December. If this is supposed to be paid from the next plan year, it's too easy for the employee to tack on $700 to his/her election, since the expense is already known.

If you now state that this employee should have never had the DCFSA, you might be able to get away with this if you can show that you have applied a similar policy in the past. For instance, say this employee did not terminate, and this never came to light. You would have taken payroll deductions, and built up a DC balance ready to use before the baby was ever born. Once the baby is born, do you have claims procedures in place which would have prevented reimbursements from the balance sitting in the account, and only reimburse amounts deducted from payroll after the birth? Probably not. If you have made no effort in the past to enforce this “eligibility at the time of payroll deductions” idea, then I think it’s risky to hold up the never-used provision. In principle, I agree with the idea that she never should have been allowed to start the DCFSA. When an employee elects Employee plus Spouse medical coverage, the HR department is sure to get information about the spouse before proceeding. Similarly, if an employee elects a DCFSA, the HR department should get information about the dependent. If the employee cannot produce information, then there should not be any DCFSA. This should start, but it should start at the next open enrollment, not in the middle of this year just to help an employee change her mind.

I hate it when employees do this. The birth of the child is a family status change, so the DCFSA should have just begun then. I know the employee wants the total election split over more paychecks so that the take home pay is not destroyed after the baby, but these are the things you run into. Employers should not allow DCFSA's without qualifying dependents already in place. The IRS has said that a mistake such as electing a DCFSA when you don't even have a qualifying dependent can be rectified. Their intent, however, is that this is only OK because it was a mistake (i.e., the employee meant to elect a HCFSA or the election documentation infers that you have to elect every benefit). This case is not a mistake. This employee is changing her mind. While I understand her predicament, there's nothing she can do.

Yes, you can change the investment vehicle within your Roth IRA. If you do plan to do this, be sure to explain to the new custodian that you already have a Roth IRA, and that you wish to perform a direct custodian to custodian transfer of the entire amount. The new custodian will typically handle everything, once you have their required forms completed. Fidelity's Destiny Fund invests in large cap growth companies. Even though it has lost over 16% over the past year, this is only slightly worse than the S&P 500 index. The fund is actually getting better, since its 3 and 5 year comparisons are a bit further off the S&P 500. Its expense ratio is a relatively low .37%. Frankly, if this money is for a retirement which is more than 10 or 15 years away, this fund will be fine. It has gone down because the market on the whole has gone down. It's extremely difficult for fund managers to consistently beat the index which their funds are compared to. Almost everyone is losing some money. You're not alone. With a down market, there are no places for you to put your money that have no risk of further loss, assuming you want the money in equities. Sure, you won't lose money in a money market fund, but there's no inflation protection, and your money won't be in the game when the tide turns. When the market turns around, this fund will turn around. When the market goes up 10% for a year, this fund will be up around 10%.

The IRS really only wants to make sure that everyone stays under $5000. You should only allow $3336 ($5000-$1664). This keeps him under your company limit, and keeps him under the IRS limit. If he had not been honest and up front with you and elected the full $4992, thereby getting more than $5000, he would end up paying tax on the amount which exceeded $5000 when he goes to fill out his Form 2441 for 2002.

I have more. This one has really got me thinking. To answer your specific question, if a 1X salary is provided by the employer and this amount exceeds $50K, then the employee has to pay imputed income on the amount that exceeds $50K. I know what you are saying concerning pre-tax payroll deductions and how they effectively turn into employer payments. Say you take pre-tax payroll deductions for premiums for GTL over $50K then pay imputed income. If you are saying that these pre-tax payroll deductions turn into employer contributions, then: Imputed income = (Dealth benefit-$50K) * rate per thousand – employee payments Since employee payments in your argument are zero, then imputed income equals the premium for the amount over $50K times the rate per thousand. This is the premium. You have just turned it into post-tax dollars, again. You would have ended up in the same position if you had just paid the premium post-tax, rather than pre-taxing it and then paying imputed income. It’s exactly the same. Paying imputed income is not less than making post-tax premium payments.

I am also talking about group policies. The way I have always seen this done is this: Say an employee makes $30,000. The employer provides 2X salary, and supplemental is offered to the employee. In this case, 2X is $60K. The employee gets the $50 from the employer no problem, then $10K ($60K-$50$) is imputed income. This would be 10 times the life rate per thousand for the employee. Whatever this comes out to is imputed income. As far as the supplemental coverage over $60K, this is paid through after-tax dollars, and there is no imputed income. With imputed income, you are not paying taxes on the death benefit. You are paying taxes on the premium payment which is being provided by your employer over and above the allowable $50K. If Section 125 did not allow for any life insurance to be a non-taxable benefit, then all payroll deductions would have to be post-tax. Since 125 allows for $50K, then only anything above that must have its premiums taxed. That's why when an employer provides anything over $50K, the premium that relates to the amount over $50K must be reported as imputed income.

So, if you are willing to have the amount over $50K go to your heirs as a taxable sum, then can you legally force your employer to take the deductions pre-tax? Again, I can see no practical, real-world reason to do this. But can it be done? I don't believe I've ever seen it before.

I think that would be correct if the insurance over $50,000 is provided by the employer. Imputed income is calculated by taking the amount over $50K, multiplying that by the rate per $1000, then subtracting the amount of premium paid (after-tax, I've always thought) by the employee. If the employee pays nothing, then the entire amount over $50K is imputed income. If the employee pays for the insurance over $50K based on his/her age bracket and the dollar amount over $50K, then imputed income is brought down to nothing. In essence, we outlined the situation of a person paying for insurance over $50K with after-tax dollars, and the death benefit is tax-free. Imputed income takes premium amounts that an employee does not pay for life over $50K and forces it to be, effectively, a taxable premium reimbursement to the employee, thereby maintaining the tax-free death benefit. I think Notice 89-110 supports this. The more I look into this, I don't see that any pre-tax deductions can be taken for life insurance over $50K. I was equating life insurance with LTD, for instance, where pre-tax deductions yield taxable benefits and post-tax deductions yield tax-free benefits. I now don't see how this can apply to life over $50K. I'm going back to my original statement that pre-tax deductions can never be taken for life insurance over $50K. Can anyone think of something contrary to this? Am I missing something?

Yes, actually you are correct, and I should have pointed that out to akwallace, as well. In the real world, I think this is not a useful option. It would mean that the death benefit over $50,000 would be taxable to the beneficiary. I can think of almost no reason that a person would want to take relatively miniscule pre-tax payroll deductions and realize such small upfront tax savings and be willing to allow a potentially huge death benefit to go to an heir as a taxable sum. Even if a plan had been mistakenly taking pre-tax deductions for amounts over $50,000, I would correct the plan before letting it go status quo.