Lisa Hand

Your question is merging several different rules. First, greater than 2% shareholder of an S corporation may not participate in a Section 125 plan in any category. For corporations, the 25% rule is the maximum overall plan participation for key employees. The dependent care testing requires that non-highly compensated account for 55% or more of that benefit.

Expenses are not considered "incurred" until the service is rendered. As with all expenses in Section 125 plans, it is not incurred "when it is formally billed, charged or paid" but rather when the service is given. If the actual service did not take place in the plan year, it is not a valid expense.

It is an administrative error, not a change of status event and should be treated as such.

The regulations permit changes based on valid change of status events which are consistent with the change which is being requested. Plan documents may further restrict this or not permit them at all. You should consult the final regulations on change of status issued March 28, 2000 for a list of valid changes and how the consistency rule applies. Pro-rating is a plan design issue. Expenses are eligible only if incurred during the period of participation in the plan.

1. For short plan years, amounts can be prorated and it would depend on whether the plan documents were written that way. It is a prudent plan design for several reasons. 2. The "Use it or Lose it" rule of 125 is not a choice, it is a requirement for the entire plan. However, that said I think your question is combining two different rules. The "Use it or Lose it" is on employee elections and means that the employees must claim amounts pit of their benefit with valid expenses incurred during the plan year or they will forfeit the remaining funds. The issue on the employer side is the level funding requirement of the Unreimbursed Medical FSA benefit. There is not a similar "risk" with the Dependent Care FSA because the funds are not received in advance. Please feel free to email me if you have further questions.

jgroves - just a quick clarification - that applies to the Unreimbursed Medical FSA, not the Dependent Care FSA since Dependent Care is not level funded and therefore you can not get the funds in advance. The most recent responses were asking about the close-out period on Dependent Care, I just wanted to make sure no one got confused. Lee Ann - As I mentioned earlier, the plan documents should detail the operations of your plan. The plan sponsor is required to provide you a copy of these documents upon request. Unless specifically stated otherwise in the plan documents, the close-out period is usually the same for terminated as active employees, just the period in which the expenses must have been incurred differ. Also as Joe mentioned, if your Medical FSA benefit has available credit as of your date of termination and your employer is larger than 20 employees (or voluntarily offers COBRA continuation) then you must be offered COBRA for your Medical FSA. (only the Medical FSA)

The close-out period is normally for all benefits within the plan. You should check your plan documents.

Treas. Reg. 1.125-4 (iii) Employment Status. "; a commencement of or return from an unpaid leave of absence;" is listed as a vaild change of status event. Whether the employee can make a change depends on your plan documents say and the change the employee wishes to make must be consistent with the event that occured.

Joe's answer to the terminating employee should also answer your question.

Pam: The law concerning reservists and their rights is The Uniformed Services Employment and Reemployment Rights Act (USERRA) of 1994. DOL Title 38, USC http://www.dol.gov/elaws/userra0.htm Please note this law covers employees, not former employees. I will take a look at my legal guide on Cafeteria Plans on Monday. However, if this is a former employee, who did not continue under COBRA with this benefit, I do not think the law applies. Hope this helps.

Data Path out of Arkansas has software for 132 Plans or you can hire a TPA who provides this service. My email is lhand@adminnw.com, I can send you their phone numbers.

Pam: There is a law which details employment rights for returning reservists. I will be able to research it on Monday. However, I believe it only applies to individuals who were current employees when placed on active duty. Please clarify your comment - "abandoned job in 1999, gets called to...." Was this individual an employee when placed on active duty? If not, then what is your close-out period for terminated employees, is it the same as regular full year participants or from date of termination? Did this individual elect to continue their medical FSA under COBRA? Were the expenses incurred while the individual was participating in the plan? When did this person return from Kosovo? Finally, you may want to post this question on the Cafeteria Plan work group since medical FSA is part of a cafeteria plan. I am the guide on that work group. [This message has been edited by Lisa Hand (edited 06-24-2000).]

SandiY: The Employee Benefits Institute of America publishes a great Cafeteria Plan legal guide which includes all of the pertinent regulations. They also have a great web site, www.ebia.com Also, please take a look at the revision on my earlier response which was incomplete, as well as Joe Priselac's response to another recent similar question. The key issue is the period of participation and when the expense was incurred.

Please give us a bit more information. Is the spouse able to make elections at any time during the year? If it is not during the spouse's open enrollment, how would that valid change of status event apply?

A number of people who get W2s are not permitted to participate in 125 plans, for example a greater than 2% S corp. owner/shareholder who is also an employee of the S corp. The definition of an employee and the regulations as they relate to a 125 plans are what needs to be looked at in this situation. If the LLC member is considered a partner or member (100% ownership would obviously fall in this category), then they are not permitted to participate. If it were still a P C then it would depended on how it was structured, corporation or S corp, which would determine the level, if any, this owner could participate. [This message has been edited by Lisa Hand (edited 06-05-2000).]

For federal tax purposes, LLCs are generally treated as partnerships. To the extent that an individual member of an LLC is treated as a partner in a partnership or as a self-employed person, it is clear that they may not participate in a cafeteria plan.

While reviewing previous postings for a response to another one, I noted an error in this one. It is greater than 2% shareholders in an S Corp that can not participate in the 125 Plan.

Prop. Treas. Reg. 1.125-4, Q/A-7

If the expense is prior to their termination from the plan, then valid incurred expenses must be reimbursed up to the annual election. ****Sorry guys about the orginal posting, I was scanning the work group too fast and misworded my response. Sorry for any confusion. [This message has been edited by Lisa Hand (edited 06-10-2000).] [This message has been edited by Lisa Hand (edited 06-11-2000).]

Regardless of the ownership percentage, if they are not affiliated, then each organization would sponsor their own plan and participation would not be transferable between the two because they are separate entities.

What does your plan document say about how elections should be handled? Based on the posting so far, I would say a complete audit of your 125 Plan (as well as anything else the previous person touched) is in order. You are probably looking at a much greater range of issues than this one person's election discrepancy. You might want to consider working with a TPA which by the nature of that relationship provides the double-check for the plan on a number of different levels.

Prop. Treas. Reg 1.125-1, Q/A-17, "Third, the medical expenses that are reimbursed under an accident or health plan must have been incurred during the period for which the participant is actually covered by the accident or health plan in order for the reimbursements to be excluded from gross income under section 105(B). For purposes of this rule, expenses are treated as having been incurred when the participant is provided with the medical care that gives rise to the medical expense, and not when the participant is formally billed, charged for, or pays for the medical care...." There is no regulatory requirement for a participant to pay an expense prior to be reimbursed. The date of service is when the treatement is provided and if the applicable insurance is going to pay a portion is has done so. Since Lasik is not on-going treatment, such as orthodontia, the date of service is the date the procedure is performed and the expense is for only the plan year in which it occurrs.

Do the two organizations have separate tax ID number? Ownership aside, how are the affiliated?

Do you have a TPA (in which case you should discuss this with them) or are you self-administered? How could this occured for several years, if it is for an FSA?

The basic issue is that a cafeteria plan is defined as "written plan under which (A) all particpants are employees, and (B) the participants may choose amoung 2 or more benefits consisting of cash and qualified benefits." It is an employee benefit and the sponsoring organization must be the employer. Additionally, participation in the plan is determined by employment and eligibility status, in direct opposition to portability. A discussion with the IRS on the legality of this idea would be in order prior to any other discussions.