125 double dipping

[Guest Dolores Lawrence]

RE: Double dipping schemes under Code Sec 106-as discussed in EBIA cafeteria manual pg 251-employees pay total premium through 125 plan and employer then reimburses employees for part of what they paid on a pre-tax basis - has there been any IRS comment on these plans? Purportedly, the sellers of these schemes are now saying they offer "audit protection." Is there anything to their ability to make such an offer?

[GBurns]

Anyone can offer "Audit Protection". The problem is will you get it and what are the conditions under which it will be delivered???

The biggest problem that I have with it is that the President of the company offering the "Audit Protection" has no idea what he is protecting and never investigated it. He said that the promoter and the promoter's CPA told him that it was a legal product. That was it!!

I also found a couple of their clients who thought that they had "Audit Protection" as part of the package with the price included in their Administration fee. However, the President of the "Audit Protection" service said that there is a fee for coverage that is separate.

I suspect that there are a lot of people who think that they have coverage that might not exist for more than 1 reason.

Regarding what is in the Manual: The main reason why that plan has been able to make progress is because of that discussion in the manual and articles based on it or similar that have appeared in newsletters. The Manual does nor reflect the plan in anyway and the sales reps are able to easily show that since it reflects some other plan, then their plan must be ok.

There have been many warnings put out by others such as William Mercer in their May 14, 2001 Grist Report and Ernst & Young in a May 14, 2001 Tax Alert. Most of the articles are not very accurate and have only served to help sales. It now turns out that the authors are too embarrassed by their weak and inaccurate articles (similar to what is in the Manual etc) to issue corrections and are waiting on the IRS, the DOL and a number of State DOI to protect the public.

The IRS/Treasury has included it in their 2001 Priority Guidance Plan as an item for which guidance will be issued and a Revenue Ruling is overdue but should be out soon telling why that plan does not work. It is hoped that the ruling will also address penalties.

[SLuskin]

This double dipping scheme was a big topic of conversation at the EBIA 2 day Cafeteria Plan Seminar that I attended. We were told that the IRS is now aware of these schemes and we can expect lots of activity soon. We were told that IRS Cafeteria Plan guru Harry Beker did not think much of these plans and the consensus was don't sell them to your clients. I have been advising agents who bring me business not to touch those plans, even when they complain that they are losing business to competitors who are putting in these plans. It is better to lose a client than to lose your license.

[IRC401]

G Burns-

Do you have a link to the Mercer or E&Y articles?

Unless I am missing something, this is a relatively simple issue. Benefits paid with pre-tax dollars through a cafeteria plan are employer provided benefits. Any payments that an employer makes to an employee for services are taxable wages unless they fall within an exception. An employer may not use Code sections 104-129 to reimburse an employee on a tax free basis for expenses that the employee had covered by insurance or otherwise didn't pay. Therefore, the second round of "reimbursements" is really a payment of taxable wages.

I have no idea what the "audit protection" covers. The cafeteria plan isn't at risk. The employer is at risk for failure to properly report and withhold wages. Furthermore, any activity that is based on wages, such as 401(k) contributions, ADP testing, top-heavy benefits, etc., will be handled incorrectly, possibly creating some unpleasant complications.

Am I missing something ????

[GBurns]

You are right, it is a very simple issue. You cannot reimburse on a tax free basis the premium that was deducted on a tax free basis for many reasons.You have a lot of people who look at the sales literature and come to that conclusion.

However, that is where the problem lies.

Because that is not what the sales literature says. Their sales literature including brochure, FAQ and Plan Document all clearly and very often state that the plan is an Accident and Health/Medical Reimbursement Plan and that it reimburses the employee for the expenses of medical care. the Plan Document even gives the procedure for submitting claims in order to get reimbursement.

One of the reasons why people buy the plan is because the sales reps can easily point out that the so-called "expert" could not even read the sales literature properly and therefore was not capable of rendering a valid opinion.

Once the sales rep discredits the expert's opinion he can then embellish freely. The claim is made that the tax free payment is not a reimbursement of the pre tax premium but an actual benefit fron an accident and health/medical reimbursement plan. If the client is astute enough to ask how the claims submission and adjudication works, it is pointed out that the employee does not really need to submit receipts or actual claims. An explanation is given of Treas Regs 1.125-5 Q&A 7 (B)(5) and (6) regarding Claims substantiation and Claims incurred which clearly state that the employee does not have to have paid the expense etc. A very spurious claim is also made regarding the wording of IRC 213(d) which does include the term "insurance premiums" in the allowable expenses and to the definition of "wages" found in 3401 and 3121.

Believe it or not people actually buy this story.

But this is not the main reason why that particular HI Plan does not work. It does not work because it does not do what the Plan Document and sales literature claims. It does not qualify as an A&H Plan, and it does not qualify as a Self-Insured Medical Reimbursement Plan under 1.105-11. If it does not qualify then deductions and exclusions would be disallowed.

In a nutshell what is presented is not what is delivered.

The Audit Protection is supposed to provide representation in case the plan or the employee is audited in connection with their HI Plan. The provider is not conversant with that particular plan and I dont think he has any idea what he got himself into. according to the IRS top experts (not Mr. Beker) the 125 plan is also at risk for allowing deferral of compensation and also, in some plans, for violating the regs. for FSA as per 1.125-2 Q&A 7 (B) and 1.125-1 Q&A 17.

The link to E&Y and Mercer are now restricted to paid subscribers but I can email you what I downloaded. As you will see these "experts" also did not understand the sales literature that they read and make references and cites that are not used by any of the HI Plans thereby allowing the reps to state convincingly that the "expert" must be referring to some other plan and not theirs. The other plan must be the bad one therefore theirs must, by a process of elimination, be the good one. Many people have even got approvals from the IRS telephone CSRs.

[IRC401]

Thank you for providing so much detail.