Employer Funded Spending Accounts

[Linda]

A plan sponsor is considering a medical reimbursement account program where each (non-high paid) employee would get $X credits per month and no employee contributions would be accepted. Credits would carry over year-to-year. At termination of employment, any credit balance would be applied to COBRA or retiree medical premiums (and could not be converted to anything taxable). If for any reason the credit balance could not be used by the participant and his or her family for extended medical coverage, the credit balance would be forfeited. The arrangement would be funded through an existing welfare benefits trust.

Since no employee contributions would be accepted, 125 would not apply. So, since 125 does not apply, do you see any problem with carrying over credits year-to-year? Is there a risk that (due to the carry-over) the arrangement might fail to be a group health plan under Code Section 105? How would COBRA apply to a (potentially large) credit balance in the event of a participant’s divorce?

[GBurns]

There is nothing in 105 that says it has to be a group health plan.But, the plan has to show elements of insurance, such as the shifting of risk, so you might have other problems caused by the accumulation of any money that could be used for other purposes. Also, the availability, even eventually of the money, could violate the constructive receipt rules and the old assignment of income doctrine.Therefore, the money must never become the employees.

[Linda]

You have touched on one of my concerns. Although 125 does not apply if there are no employee contributions, Prop. Reg. §1.125-2 Q&A-7(a) states that benefits under a medical spending arrangement will be taxable to participants under Code §105 if the arrangement does not “exhibit the risk-shifting and risk-distribution characteristics of insurance.” Apparently, the IRS intended this principle as an amplification of Code §105 because the paragraph concludes “These rules apply with respect to a health plan without regard to whether the plan is provided through a cafeteria plan.” If the same idea were a final reg. under 105, I think it would be a stumbling block to employer-funded medical spending accounts with carryovers (even if the money could never be used for anything other than health benefits). Since this is a proposed reg. under 125, I’m not sure how much weight to assign it. Any thoughts?

[GBurns]

Linda. Almost everthing that is done under a 125 Cafeteria Plan is done under either Proposed Regs or Temporary Proposed Regs. How can you then question how much weight can be placed on the Regs. that is all everyone has been operating under, especially with the refusal to issue Determination Letters or Private Letter Rulings since 1989. Look for the first Final Regs on 125 in early Nov, these will mainly be 1.125-4T but there will be some important othe line items from the other Prop. Regs.

[Linda]

This one portion of the proposed 125 reg purports to be an interpretation of 105 -- an interpretation I don't see anywhere under 105. I just wonder what the IRS was really intending for non-125 medical spending accounts. So, how much insurance-style risk do you think is needed for 105 to apply to an employer funded medical spending account (i.e., subject to 105 but not 125)?

[GBurns]

The risks that come to mind first are:

1.The arrangement must be made before any expenses are incurred.

2. Coverage cannot be purchased on an expense by expense basis

3. The full amount of reimbursement must be available regardless of the amount contributed. If the employer had only put in 1 month's worth, the employee can spend the whole years amount anytime.

4. The employer cannot deduct anything from the employee.

If the employee in Item 3 then left the job the employer would have to stand the loss, that is an insurance risk.Treas Regs 1.105-11 reads almost the same as 1.125-1 Q&A 17.