Flexible Spending accounts

[Guest DFCTony]

What action can an employer take to be reimbursed from a terminated employee who has been reimbursed from their FSA for amounts that exceed what has been collected? For example: An employee elects a $1200 yearly allocation and has tax-deferred contributions of $100 per month. Six months after enrolling they've contributed $600 but have been reimbursed for $1200. They quit. Can the employer legally attempt to collect the non-contibuted $600?

[papogi]

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.

[Guest b2kates]

It appears that the employer is stuck legally, the 125 regs require the payment. And the plan is operated "like an insurance contract".

I think only moral persuassion is left to employer.

[mroberts]

You're out of luck. Call it a day and move on.

[MGB]

I disagree that "moral persuasion" is an option. There should be NO attempt to recoup the money. That is how an FSA operates, pure and simple. There should be no feeling by the employee that they owe anything back. Nothing more should be said and the employer should not try to make the ex employee feel guilty. If the employer tried to collect the money, in my (nonlawyer) opinion, the employee would have a cause of action against the employer in court with the DOL backing them up.

[mroberts]

I couldn't agree more. I was in a rush before when I typed my last response.

[KJohnson]

On the old 125 Q&A column, this Plan design was suggested. I think this could work but it may be more trouble than it is worth.

Some plans require all participants to pay the annual election amount - even if such a participant terminates. This provision must be applied uniformly, however. In other words, a company may not collect from the last pay check of only those participants who have a "negative" balance. In such a plan design, they would collect the remaining annual contribution from any terminating employee -- regardless of claims to date.

[mroberts]

We went through this before and I don't see how this is legal. The reason that a section 125 gets tax-favored treatment is because of the risk associated with it. I would like to see a legal expert explain to me why this is legal. Furthermore, studies have shown that everything pretty much balances out in the end. Meaning that just as many employees leave a company with balances in their section 125 account than people who max out their allotment before all the deductions are made. Why go through a big hassle to save $42.36?

[KJohnson]

As to your first point, the uniform coverage requirement is that the maximum benefit cannot relate to the amount paid and the payment schedule cannot relate to the claims incurred. In the above example you have neither of these problems. Everyone must pay 100% of their annual election regardless of claims incurred. As the example in the regulation states, the plan cannot provide acceleration because of incurred claims and reimubrsements. In the example above, everyone is being accelerated regardless of their claim status.

As to your second point--why bother-- I couldn't agree more.

[papogi]

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.

[KJohnson]

I completely agree that coverage would have to be provided for the entire year. The risk shifting aspect of the regs has always bothered me. The regs specifically contemplate that you could have a semi annual payment schedule. Say you agree to do this and deduct amounts from paychecks only on January 1, and July 1. Wouldn't you have eliminated all risk for the rest of the year on July 1 (because in addition to the refund issue the regs also say that you can cut off future coverage for anyone who does not make the July 1 installment).

Also, just so you know, it was not my example it was the one given in the 125 Q&A column on Benefits Link

Lowering Employer Risks Under Medical Expense Reimbursement Accounts

(Posted April 7, 1997)

Question 7: How can a company sponsoring a Section 125 plan lower its risk when designing a medical reimbursement account as part of the plan?

Answer: It won't be easy. Treasury Regulations §1.125-2, Q&A-7(a) states that, "A health FSA [flexible spending account, also called a medical expense reimbursement account] will not qualify for tax-favored treatment ... if the effect of the reimbursement arrangement eliminates all, or substantially all, risk of loss to the employer maintaining the plan or other insurer."

Some plans require all participants to pay the annual election amount - even if such a participant terminates. This provision must be applied uniformly, however. In other words, a company may not collect from the last pay check of only those participants who have a "negative" balance. In such a plan design, they would collect the remaining annual contribution from any terminating employee -- regardless of claims to date.

Other plans limit the amount that may be contributed to a medical FSA. Generally, such a limit ranges from $1,200 per year to $5,000 per year.

The regulations allow for a company to take the participant contribution in larger installments. The example given in the regulations is semi-annual. (See §1.125-2, Q&A-7(B)(2), Example 2.) This plan design is probably not often used. It would allow, however, for the company to receive 1/2 of the annual contribution "up-front," and the remaining amount for the year at the beginning of the seventh month. According to the regulations, if a participant terminates under such a plan, the plan might owe back to the participant amount paid for coverage after the participant's termination date, assuming no COBRA continuation. See §1.125-1, Q&A-7(B)(2).

The method of reducing risk that is not allowed is for a company to require from the last pay of a participant, a payment that equals the amount that was paid out in claims in excess of that participant's contribution to-date to the medical reimbursement account. This is also described at §1.125-2, Q&A-7(B)(2).

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Important notice: Answers are provided as general guidance on the subjects covered in the question and are not provided as legal advice to the questioner's situation. Any legal issues should be reviewed by your legal counsel to apply the law to the particular facts of your situation. The laws, regulations and court decisions in this area change frequently. Answers are believed to be correct as of the posting dates shown. The completeness or accuracy of a particular answer may be affected by changes in the laws, regulations or court decisions that occur after the date on which that Q&A is posted.

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Copyright 2001, 2002 R. C. Morris, Incorporated

[papogi]

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.

[KJohnson]

By the way, I just glanced at the BNA Cafeteria Plan portfolio and they give the exact same example. They do not raise risk-shifting questions but do raise some COBRA issues and the obvious state law questions regarding whether you can actually "attach" the last paycheck.

[KJohnson]

Also, I think your prior cite to the reg is inapplicable because you would be giving coverage for the entire year after you take the second installment regardless of whether they terminate employment. Accodingly, there could never be a "revocation" after the second payment which is the condition precedent to a refund.

[papogi]

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!

[KJohnson]

It is kind of amazing (I know that some would say sad) that there is a group of people that find this stuff interesting-- but I no longer shy away from the admission that I do like it.

[Guest Jeff V]

I understand that an election for MED FSA must be uniform and that an OE election needs to be allocated over the entire year. But what about Dependent Care FSA? Can an employee sign up for (example) $5,000 but stipulate they want $500 to come from each bi-weekly pay period, so that they can get reimbursed the entire $5,000 after the first ten pays?

Thanks in advance.

[papogi]

I can’t think of anyplace where the IRS specifically disallows this, but this would have to be something that the employer offers to everyone, and the employee cannot make this demand of his or her employer. It seems to go against the intent of the legislation, and also sets up the employer for some potential problems should the employee terminate mid-year (e.g., undue risk to the employer in a DC area where there should be no real risk-shifting)

[Guest AHayhow]

If the plan collects the entire health care FSA "premium" and therefore allows employees to continue to participate in the plan (i.e., incur expenses and request reimbursement) even after termination, how would you get around the eligibility requirements? Would it just mean changing the SPD and plan documents to reflect eligible employees as any current and former employees?

For instance, most of our plans indicate eligible employees are employees actively at work (some with a minimum requirement for the number of hours worked per week). In fact, the mere term "eligible employee" indicates that the person is an employee. If someone terminates employment they aren't an employee anymore and would only be able to continue under COBRA (if applicable).

[TPApril]

Related question - employee has given early notice for 3/1 of next year. during enrollment, he has elected the maximum health fsa contribution. knowing that he will only contribute 1/6 of that, are there any options for the employer, or like the thread above, employer must just let it be, knowing ee may take it all out?

[GBurns]

Just let it be.