Non-Code Section 125 flexible benefits plan question

[Guest LLandau]

The Scenario:

ER pays 100% of premiums for core benefits for EEs. Benefits are non-taxable medical, dental, vision benefits. Whatever is not used by an employee is put into an FSA for the employee (employees do not receive cash back).

However, each EE has the option of up-grading the core requirements with salary reduction dollars.

Question:

I know that this is not a Section 125 plan if an EE has no option of upgrading the coverage and the unused allocated portion is put into an FSA.

BUT, The question is whether it remains a non-Code Section 125 FSA if EEs can pay premiums to upgrade coverage.

Any assistance will be appreciated.

[Guest Comsewogue]

The question isn't so much whether this arrangement is a 125 plan but rather, does the arrangement require a 125 plan in order to avoid constructive receipt? The answer is: yes.

The addition of the option to supplement the "non-cashable" credits with salary reduction presents the potential for constructive receipt to apply (i.e., those who salary-reduce to convert taxable wages to non-taxable health FSA coverage will be taxable on the amount of taxable wages they could have received - - unless that choice is "protected" by a section 125 plan).

[Guest LLandau]

Could you give me further clarification?

If this is a Section 125 plan because EEs may upgrade their benefits using salary reductions contributions, does that then mean that the ER is precluded from putting the unused portion of the ER contribution (for core benefits) into an FSA portion of the Section 125 plan.

Or, Can a cafeteria plan have a FSA feature only for the ER's contributions?

Is it also correct that if an EE chooses to have a salary reduction to upgrade benefits, then an EE who does not elect to have a salary reduction to upgrade benefits has the option of receiving cash in the form of unreduced compensation?

[Guest Comsewogue]

1. If you wish, the plan design can call for some or all of the unused potion of the employer-provided credits to be directed to the FSA, where those dollars may be combined with an employee's salary reduction contributions to the FSA.

2. Alternatively, the employer could establish an FSA that received only the unused (non-cashable) credits and no salary reduction from the employee.

3. That's right, with salary reduction an employee is effectively telling the employer to "Pay me less and give me a tax-free benefit" (i.e., the employer's contribution toward my upgraded benefit). The employee who declines salary reduction is effectively saying, "I'll take cash instead, in the form of my normal wages."

[GBurns]

Simply put, as long as there is a choice given to the employee to do a salary reduction or to not do a salary reduction, you should do it through a section 125 plan.

Of course, based on your plan design and employment contract you could follow the example of EXpress Oil Change and a few others who did not use a section 125 plan and yet defeated an IRS challenge in court on this constructive receipt and salary reduction issue.

[Guest LLandau]

GBurns:

Do you have a cite for the Express Oil Change case, or some further information so that I can track this down.