Employee elects salary reductions but no deductions taken in fact from

[Guest SheilaLuken]

How would you correct this situation: employee becomes eligible for the 125 (calendar year) plan on 6/1/02. For some reason, no deductions were ever made. The employee never notifies the employer that no deductions are being made and never submits any expenses for reimbursement. It is now after the end of the plan year and employee notifies employer that no deductions were made (but has not yet submitted reimbursements or even mentioned them). Employee does however, want the tax benefit of his election, presumably all at the marginal rate.

[papogi]

I’ve never seen any guidance from the IRS on anything like this. I think you have several possible options. First, the employee can and should take some responsibility for this in not taking the time to look at paystubs (that’s why he gets them). If employees are allowed to make mistakes, employers should be allowed to, as well. He had an entire year to notice this and have it corrected within the plan year. So, the whole election could be made null and void. The employer and employee lose their tax benefits, but the employee gains the assurance that he got his entire election through payroll, with no chance of forfeiture. Another option is to let him keep the money, submit eligible claims for the past year to the claims processor to justify his having the money, then the employer could reimburse him an amount of money which represents his lost tax savings (the tax taken out of the FSA amount through payroll), plus the tax on that, since it will have to be given to him with after-tax dollars. The employer is still out their tax savings. Lastly, he could send a check to the employer which represents the entire past year’s election, reduced by the taxes he paid on that money but shouldn’t have. Then, with eligible claims, he would be reimbursed the full election. The employer is out their tax savings in this approach, as well. You can brainstorm potential problems with any of the above options. Any one of them could be argued as being a fair and honest attempt to correct the wrongdoing, however.

[Kirk Maldonado]

Tell the employee that you will be glad to submit this question to the IRS for a private letter ruling. Tell him that you are going to tell the IRS that he is going to try to evade taxation on amounts that he actually was paid. Of course, as part of the submisison, you have to provide the IRS with his name and social security number.

That ought to dissuade him.

[jpod]

There is no solution here that would allow the employee to reduce his income and fica/medicare tax liabilities for 2002. That doesn't mean, however, that he is has no recourse.

If I were the employee, I would ask you to pay him the taxes he would have saved, plus a gross-up. I'm not sure what the employee's legal cause of action is, but I bet he has one.

If I were the employer, I would respond by saying that the employee was at least partly to blame, because if at any point before the end of the year he had brought this to our attention, it could have been fixed by piling up on the pre-tax deductions before the end of the year.

I think a court would probably split the baby.

[GBurns]

I must have really missed something here.

This seems to be an FSA within a section 125 plan and not medial insurance premium, because Sheila talks about expenses not being submitted.

If the deductions (reductions) had been taken from the employee at say $50 per month the employee would have contributed $350 to the FSA and now that the year has ended and no claims for reimbursement were submitted, the employee will now forfeit the $350.

What benefit does this employee see in losing the amount deducted? It certainly is much more than the reduction in taxes.

$350 vs $70.

If however, the deductions were for health insurance premiums (forgetting Sheila's statement about expenses), the employee is not complaining about not having been covered for health insurance and therefore it must not be an issue... why would the employee now want to pay for something that he already got for free and for which no one was asking him for the money?

In this case the tax reduction is even less significant that the salary deduction (reduction). Why would he want to "give away" so much money?

Sheila....

Has anyone gone over the figures with this employee?

[Guest SheilaLuken]

The plan allows employees to submit their expenses from 2002 until the end of February 2003. Perhaps he has "saved up" his receipts, although, as stated, he has not yet indicated that he actually has medical care reimbursable expenses. He did briefly indicate that he has day care expenses for one morning a week, but the program he mentioned seems to be educational rather than childcare in nature, so those expenses are likely not eligible anyway. I personally like Papogi's suggestion of having the employee submit his expenses and reimbursing him the tax savings on those expenses.

[Guest Jeff V]

Kirk,

You're not serious about the IRS suggestion, right?

Wouldn't a private letter ruling request for (what sounds like) a plan administrative error be a red flag for audit?

I wouldn't want to go to the IRS and say "Yeah, they elected on 6/1 but we never took money out and now they want a resolution so what should we do?"

My background is DC Plans, and now I'm learning 125, so maybe you are serious and there's no analogy between PLRs for 125 and 401(k)?

Thanks.:eek:

[Kirk Maldonado]

Jeff V:

I said that because, if the employee has any brains at all, the last thing he wants is for the IRS to get official notice that he is going to take a frivolous, if not criminal, position with respect to his taxes. If taking cash but refusing to pay taxes on it isn't tax fraud, I don't know what would qualify.

[Lisa Hand]

Sheila:

Did the employee complete an enrollment form to enroll in the benefit during the valid period permitted by your plan documents when newly eligible?

[Guest SheilaLuken]

Lisa,

Yes, he did complete the enrollment form correctly and on time in 2002. He missed open enrollment for 2003 and wanted to know how he could sign up for this year when he called about the 2002 tax issue. At least that question had an easy answer!

[Guest kwn]

Be careful as to the recommendation of corrections here. The one issue that has not been discussed about is the issue of the Company payroll tax paid each month could be wrong depending on which method you take to correct this issue. You can certainly submit this issue with the IRS Cafeteria Plan Techinical Advisors and they will give you what would be a reasonable solution to this issue.

[Guest blackacre]

Can anyone tell me how to contact the Cafeteria Plan Technical Advisors mentioned in one of the previous post? Are they in DC?