papogi

Reg 1.125-2 (Q7)(B)(7) states, "Alternatively, the $5,000 [in the IRS example] may be used to reduce the required premiums under the health FSA for all eligible employees for the next plan year (e.g., a $500 health FSA for the next year might be priced at $480) or to reimburse claims incurred above the elective limit in such year as long as such reimbursements are made in a nondiscriminatory manner." I would recommend just a basic dividend or premium refund. It seems that what you are proposing is allowed, but it can raise complications in dealing with employees and their elections. For example, using the amount to raise the the reimbursable amount will only work if the employee comes up with enough extra claims to actually get the money out. Also, using the money to partially fund the employee's next year election will, in essence, lower the payroll deductions the employee intended or agreed to. While most employees welcome lower payroll deductions, there might be some reason the employee elected a certain amount in order to reduce his/her taxable income to a certain level.

I agree. Without a doubt, this is adding insult to injury for this employee, but I can't see how she can change her election. BenefitsLink has a question in the Q&A section that is somewhat similar: Changing a Health FSA Election Because New Medical Condition Prevents Planned Surgery (Posted January 22, 2001) Question 12: During the December annual open enrollment period, I elected health FSA coverage in the amount of $3,000 for 2001. The health FSA is part of a cafeteria plan with a calendar plan year. I am currently having $3,000 taken out of my pay check this year as pre-tax salary reductions ($115.38 per bi-weekly pay period). My plan was to have Lasik eye surgery. In November of 2000, I saw my regular eye doctor and he said I was a candidate for the surgery. I scheduled the surgery for a day in January. On the day of the surgery, I had to first meet with the surgeon in the morning. She examined my eyes and discovered two problems (one being glaucoma and the other being pupil size) that would make me a bad candidate for the surgery. In fact she said she would not do it because I would have poor results at best. So my question is this, can I stop my pre-tax salary reductions so I will not lose the $3,000? I wanted the surgery. That's why I signed up for the health FSA, but because of the disease discovered, the doctor will not do it. Answer: In our view, based on prevailing IRS guidance, you cannot change your election just because the Lasik surgery is not a viable option for you. Under the rules governing cafeteria plans and health FSAs, your election is irrevocable for the duration of the plan year unless you can show that your requested election change meets one of the exceptions contained in Treas. Reg. Sec. 1.125-4. Unfortunately, a change in a participant's medical condition, or a change in the advisability of having a particular medical procedure performed, does not fit within any of the regulations' exceptions. Nor is your situation a mistake that might justify the undoing of your election. When you signed up for the health FSA, you signed up for a mini-insurance plan with an annual maximum of $3,000 (the medical condition that gave you cause to elect the coverage is irrelevant). Even though your medical situation may have changed, you still have the $3,000 mini-insurance coverage available for other unreimbursed medical expenses incurred by you and your dependents during the year. As a final note, the answer above is based on prevailing IRS guidance. In the highly unlikely event that your employer's health FSA or cafeteria plan document contains language that could be interpreted as giving you the right to change your election in these circumstances (i.e., a change in the advisability of having a particular medical procedure performed), you might have a valid contract-based claim under ERISA. (Such plan language, if it exists, would cause the health FSA and cafeteria plan to be out of compliance with Internal Revenue Code requirements, with possible adverse tax consequences.)

The only money your son can put into a Roth IRA is $3000 (this was just raised from $2000 last year) or up to his earned income if less than $3000. Since I'm sure your son has no earned income, he is not and was not ever eligible for a Roth IRA. As for your Roth, if your combined modified AGI is over $160,000 (married, filing joint), you can't contribute to a Roth IRA either.

Yes, you will have to pay a penalty if you withdraw funds from a Roth IRA after only 2 months. You must keep it there for 5 years. After that, a withdrawal of Roth IRA funds before you are 59 1/2 results in the earnings being taxable, and a 10% penalty applies if the money is not used for a qualified expense. Qualified expenses include a down payment if you are a first-time home buyer, or expenses related to higher education. There are other QE's, but these are the more commonly used ones. While it is usually a good idea to convert regular IRA's to Roth IRA's (not in every case, but most), understand that the conversion will result in your paying taxes on probably the entire amount. Your 401K was most likely made up of pre-tax deductions from your pay, as well as non-taxed employer contributions. A Roth IRA is, by design, comprised of taxed funds (hence the tax-free nature upon their withdrawal at retirement), so when you convert your regular IRA into a Roth, you will need to report that entire amount as taxable income in the year you make the conversion. Without knowing your specifics, Roth IRA's are generally better than regular IRA's because the tax-free withdrawals will be much easier to manage (less paperwork), many people end up in a higher tax bracket when they retire (as you predict), and the lack of mandatory withdrawals form Roth IRA's (simplifies some areas of estate planning). Each person needs to run the numbers to see whether a deductible IRA or a non-deductible Roth IRA works better for them. Most find the Roth option better.

There have been several court decisions related to this, some going one way, some going another, but the consensus is that oral elections are allowed. It is srongly recommended, however, that this question be addressed in your plan doc as well as on your COBRA offer letter. Even though oral elections can be allowed, you are under no legal constraints to allow them if your plan doc and offer letter specifically require written agreements.

If the plan provisions say that the individual terminates as of the date the lifetime limit is reached, then a loss of coverage has occurred. As an aside, one would think this should be a COBRA event, although why would someone pay COBRA premiums for a plan in which the limit has been reached? There would be no benefit. Anyway, yes, Medicaid is certainly considered creditable coverage.

I agree with your reasoning. They still have the coverage, although the benefit of the coverage is worthless. As long as the employee is enrolled in the plan, there should be no break. Keep in mind that the IRS sees situations like this as a status change, and the employee can drop coverage to cease payroll deductions, as long as your plan allows it. Then, of course, the 63 day clock begins to tick.

The IRS gives no guidance on this. Your plan should specify who is eligible for the benefit, so the ball is in the employer's court to clarify who is eligible, and to get that info added to the SPD.

If bank #2 put it into regular account in error, meaning the signed application shows the account should have been designated an IRA, then the bank should make a retroactive correction. If this is the case, I would think that an explanation of this could be included with the client's tax forms to document why the early distribution was not being included as income, and no penalty is being paid. Wouldn't that be easy. I'm sure that your client has already gone to bank #2 about this, and I bet the set up documentation for the account clearly shows the client agreeing to a non-IRA account. If this is the case, I have heard of no exit from this. Without proof that the IRA has been in limbo for less than 60 days, I'm sure no sponsor would be willing to take this account on as an IRA. Pressuring bank #2 is his only hope. Hopefully someone else has heard of a loophole...

My interpretation of the regs in regard to this hinges on the fact that the eye exam and the purchase of contact lenses do not necessarily have to happen together. The eye exam that occurred in December is an expense reimbursable through that year's FSA. This is the "service giving rise to the medical expense", the medical expense being the charges for the exam only. The contact lenses purchased in December are also that year's expense. Regardless when they are delivered, the employee made the decision to purchase them in December, took the initial expense to purchase them in December, thus incurring the charge in December. The incurred date for the purchase of products (e.g. contact lenses, lens solution, etc.) is not tied to the day the diagnosis of a health condition or problem is made. The subsequent purchases of additional lenses in the next year, even though they are based on the prescription from Decmeber, are charges incurred during the current year. The day you go into a drug store to purchase contact lens cleaner is the day you incur that charge. The incurred date for the lens cleaner is not the day the eye problem was discovered by the optometrist. I hope I'm understanding the original aim of your question.

I've never seen this is the regs, either, but I have personally seen the practice numerous times. In the FSA, the employee enters into an agreement with the employer, regardless how many administrators handle the account in a plan year. The regs always refer to the "employer's FSA". It doesn't matter who is administering the FSA. These employees would not be classified as changing employers, even though the name on their paychecks may change. They didn't terminate, be offered COBRA, and start a new job.

Reg 1.125-4(f)(2) addresses this. A "cost increase or decrease refers to an increase or decrease in the amount of the elective contributions under the cafeteria plan, whether that increase results from an action taken the employee or from an action taken by an employer." You can require a larger amount from your employees, even mid-year. In your case, a status change has occurred, so its likely that some people might drop the coverage. There will obviously be some administrative fees attached to this (HIPAA letters, payroll changes, etc.). Open enrollment is obviously the best time to do this, especially when you have the employer-employee relationship to think of. If changes like this are done at open enrollment, it is easier to lessen the blow to the employees be reducing another cost, maybe by curtailing a seldom-used benefit. Since you are self-funded, you will have some leeway.

I don't see how payroll can recoup the cash the employee received for opting out of the plan. In the Section 125 plan, employees have a choice between taxable cash, and non-taxable benefits funded with pre-tax dollars. When the employee opts out of the plan and receives cash, they are opting out of the Section 125 plan. It's like they're starting out flat, and have no obligation to the employer with regard to the cash. If the underlying plan allows the employee to participate on an after-tax basis later in the year, the cash the employee received earlier is irrelevant. It seems we could go on about the fact that these people are being allowed on the plan without a HIPAA event, but to answer your original question, I don't think payroll can recoup any funds.

Regardless of the dates of the Section 125 plan year that an employer has, the IRS follows a calendar year for reporting purposes. Since the employee incurred no expenses in 2001, any amounts contributed to a DCFSA in 2001 will be taxable following the instructions for form 2441. Say the employee elected the full $5000, and expects the $5000 to be spread out from 1/1/02 to 9/30/02, but must elect it as of 10/1/01, per their plan year. The portion deducted from 10/1/01 to 12/31/01 (box 10 on the 2001 W-2) will end up being taxable, since no services were incurred during that time. When they go to do their 2002 taxes, the amount in box 10 will be around $4100 ($5000 minus the amount deducted from 10/1/01 to 12/31/01). The employee has $5000 worth of claims from 1/1/02 to 9/30/02. When they fill out the 2002 form 2441, they can then get the credit for the amount that exceeds $4100, subject to limits. They lost the pre-tax benefit for that amount on their 2001 taxes, but got it back on their 2002 taxes. It will all basically come out even in the end. But, following the rules, that's how it will need to be done.

It is taxable income, and there's no way around it. Page two of form 2441 is designed to isolate that portion of W-2 box 10 that was not used during that tax year. If the amounts were not used, it becomes taxable income on 1040 line 7.

I still think my cite to the IRC is correct. The example that the IRS uses [Reg. 1-125-2, Q-7(B)(2) Example 2] assumes a plan that requires a Jan 1 deposit, and a July 1 deposit, and that an employee terminates on 6/30. It then goes on to describe two possibilities. One is that the employee does not make the 7/1 deposit, and the end result is that the FSA ceases. The other possibility is that the employee makes the 7/1 deposit, and the regs say that the account must stay in force up to the end of the plan year. Assume, however, that the employee terminated on 7/31, this being a status change, and revokes his FSA on that date (If he does not revoke his FSA, the premiums are already paid, and he continues up to 12/31). Based on the wording in Reg. 1-125-2, Q-7(B)(2), my understanding is that the employer would have to refund monies that relate to the period after the termination date of 7/31. I will say that this exchange of ideas and interpretations is very interesting and educational. For what other reason would I find my nose buried in what would otherwise be described as pretty dry stuff!

In my view, the risk-shifting characteristic remains even after the July 1st deduction because of the provision saying that "the employer must reimburse the employee for any amount previously paid for coverage or benefits relating to the period after the date of the employee's separation from service regardless of the employee's claims or reimbursements as of such date". In effect, the only reason to adopt a two time contribution (Jan1 and July 2) is because it would be easier to administer. Since the employer is obligated to return the "unearned" portion in the event of a termination, the end result is the same as if the employer had taken smaller deductions from every paycheck. Risk-shifting is maintained. Thanks for referring me to question 7 in the Section 125 Q&A area. I had never read that one. Regardless of the fact that the respondent included that paragraph about this being a possible plan design, I stand by my (and I think most of our) contention that this would be a hard practice to defend in court.

If an employer follows the practice mentioned by KJohnson, there are a couple points to make. First, even if the policy is applied on a uniform basis, the IRS states that if an entire annual premium is collected, then the FSA must be available for the entire 12 month plan year [Reg. 1-125-2, Q-7(B)(3)]. In essence. the termination did not occur. The employee still has access to his/her FSA for the entire year on a pre-tax basis, and can submit bills with dates of service throughout the plan year, with no regard for the "termination date". Doing this via a lump sum eliminates the employer's risk, and removes the necessary risk-shifting characteristic. Conversely, making contributions each month continues the risk-shifting since the employee can clear out the account and stop contributions at any time. Either way, I think KJohnson's example would not stand up in court and is a risky policy for an employer to have. Secondly, employers can take FSA deductions from all participants on an accelerated basis to reduce employer risk. In these cases, however, a terminated employee must have a prorated amount of premium returned to him/her based on the proportion of the covered period versus the uncovered period [Reg. 1-125-2, Q-7(B)(2)], and the returned amount cannot be reduced by claims paid. In the end, the risk-shifting must be adhered to.

No. There's nothing the employer can do. This is the risk the employer faces in offering FSAs. Conversely, the risk the employee faces is that he/she might forfeit money at the end of the year if they can't come up with enough in claims to clear out the account. This risk-shifting characteristic is the whole reason the benefit exists with its tax-favored features.

I admit I don't know enough about state laws on this topic, and certainly not Florida. Hopefully someone else can chime in when it comes to state laws...

For a long time, only Pennsylvania and New Jersey taxed salary deferrals to Section 125 plans. Pennsylvania has more recently stopped this practice. Currently, only in New Jersey are flex plan contributions taxed.

I have been doing simlar research recently, including consulting these message boards, and using other sources. If the employer has a Cafeteria Plan, pre-tax deductions are being taken. In order to maintain these tax advantages, the IRC reasonably clearly outlines all the possible status changes that would allow any mid-year changes to the pre-tax deductions. It is important to separate the Cafeteria Plan/Section 125 from the provisions of the underlying plan. If the plan allows mid-year changes such as you describe, and I agree with mroberts that such a liberal plan is not wise, then the changes can be done, effective whenever the plan provisions specify. Such loose plan provisions would be very rare in the insurance world, even in the self-funded side of things. Separate from the underlying plan's provisions, you then have Section 125. Say, for example that your plan allows for a dependent to come on the health plan at any time, for no apparent reason, no loss of other coverage, no gaining of eligibility, etc. The Section 125 rules do not see this as any change of status, so while the employee can make a change under the plan, it can't be done on a pre-tax basis since it does not abide by Section 125. Payroll deductions for the added dependent should be taken on a post-tax basis.

I would push back to the employee to see if a statement from the dentist can be obtained that at least estimates what the 2000 charges were, and what the 2001 charges were. The dentist should have some idea as to the level of complexity of the two visits, and how to prorate the charges. In my experience, explaining to a provider the need for such a breakdown for FSA purposes is enough to get something usable. In the face of an IRS audit, it could be proven that reasonable effort was taken to substantiate the claim.

I am of the opinion that the January 2001 expense should be paid out of her 2001 HCFSA, but the 2000 portion should be paid out of her 2000 account. The IRS states that an expense is incurred whe the care is provided, not when the individual is billed or pays for the services. As an example, orthodontia expenses typically span over more than one year, and the correct procedure is to obtain a schedule of allocated payments to be certain what the dates of service are , and what the related charges are. I would think that the IRS would apply the same reasoning in this particular case. The services began in a previous year, but there are specific charges related to the 2000 services and the 2001 services, and they should be separated.

This is helping immensely, Sandra. Specifically, if the employer does not offer an after-tax option and does not have open enrollment, employees and dependents on the health plan must stay on the plan. Sandra, do you know of any related government documentation that could also be cited? I know specific situations are rarely addressed in rules and regs, but I was hoping you might have some ideas.