Reimbursement for Expenses - PRIOR to Plan Date

[Guest loricraun]

I have a small employer group in Oklahoma who is putting a cafeteria plan into place for a short plan year from 07/01/2004 through 12/31/2004. After that, they will be going on to a regular calendar year (January through December) to match the rest of their benefits. They will be set up with POP/FSA/DCAP plans.

Here is the problem: The employer has an employee who wants to contribute money into the plan so he can reimburse himself for qualified medical expenses he incurred earlier this calendar year 2004 (PRIOR to the 07/01/2004 effective date of the plan).

My thought is that he can only be reimbursed for expenses incurred AFTER 07/01/2004. The owner of the company maintains that his CPA has said that the employee CAN do this since the expense falls into the same 2004 tax year.

As always, I appreciate your opinions (and cited sources are always very helpful).

[papogi]

The CPA is wrong. Reg 125-1 Q&A 15 addresses this in the first paragraph of the answer. Elections must occur before the benefit is available. In other words, retroactivity is not allowed. Expenses prior to 7/1/04 would be known expenses, and insurance (the IRS sees FSAs as "insurance," resulting in the tax advantages given by the IRS) relies on risk.

[Guest llerner]

Definetly cannot receive reimbursement for services rendered prior to the effective date of the Plan. The CPA is most likely thinking about income tax or quarterly tax filings, not Section 125. Absolutely not and if audited, this could result in all EE having to pay taxes on any amounts reimbursed or pre-taxed retroactively as well as ER taxes. It is not allowable under any circumstances by Section 125 or the IRS. Back dating is another no no if this has occurred to them.

[Guest gchase3]

Besides the proposed reg, are there any other cites for why a 125 plan (or a premium conversion plan) should not be back dated?

Thanks.

[papogi]

I can’t think of any, but don’t be misguided by the fact that these are “proposed regulations.” The very nature of insurance is that expenses shouldn’t be known, and backdating allows known expenses to be reimbursed. Since the IRS has been clear that HC flex accounts act as insurance by shifting risk between the employer and the participant, and this “insurance” classification is what gives the benefit the tax advantages it enjoys, I think that the area in the regs concerning when the benefit becomes effective is not “proposed” at all. I can think of no court which would rule to allow backdating unless the employees were somehow and obviously misinformed with regard to their elections.

I would also add that Final Treasury Regulations 1.125-4 (addressing mid-year election changes) state that a retroactive election change can only happen in the event of a birth or adoption. This specific clarification infers again that the IRS intends HC flex accounts to work on a prospective basis only.

[GBurns]

An FSA is basically a Medical Expense Reimbursement Plan within a section 125 plan. A MERP is also an accident and health plan as per Treas Regs 1.105-5.

The retroactivity issue is partially addressed by the IRS in this link:

http://www.irs.gov/pub/irs-utl/all-cafretro.pdf

You might also want to read about Cafeteria Plans etc:

http://www.irs.gov/faqs/page/0,,id=83301,00.html

Your client probably is believing this CPA, mistakenly thinking that being a CPA means knowing about tax and employee benefit issues etc.