Is this Permissible "Retroactive" Enrollment?

[sloble@crowleyfleck.com]

I think this practice is okay--but barely ok. I would like to know if you agree or disagree.

Client pays all employees monthly, on the last day of the month. (Eg, Employee is paid for work done in January on January 31) Client allows employees to enroll in the 125 plan up to 5 working days before the last day of the month, effective retroactively to the first day of the month. Enrollment is not automatic--they have to affirmatively submit their forms or they get cash.

I think this is ok for mid-year initial enrollment under RevRul 2002-27, does anyone disagree? What about for annual enrollment (Eg Employee can submit enrollment forms on January 20, 2005 to be effective Jan. 1 2005)? What about for midpyear election changes? Do you know of any other guidance besides Rev Rul 2002-27?

THANKS!

Here is the address for Rev Rul 2002-27

http://benefitslink.com/IRS/revrul2002-27.html

The pertinent language I think is on p. 2: "For a new hire an election ... is efective if made when the employee is hired or within a reasonable time before compensation for the first pay period is currently available. For a current employee, an election is effective if made prior to the start of each calendar year ..."

[sloble@crowleyfleck.com]

I'm bumping this up... anyone? Katherine, GBurms, mbozek--to name a few 125 plan gurus...

[papogi]

I think there is a problem with retroactivity. Retro is only allowed in the cases of births and adoptions. Allowing enrollment up to 5 days before the end of the month (with the effective date being the beginning of that month) is a problem.

[sloble@crowleyfleck.com]

Thanks--have you read 2002-27? EBIA takes the position that such retroactivity is arguably permissible, at least with mid-year initial enrollments, under that ruling. THANKS for you input.

[GBurns]

I would say that the retroactivity in 2002-27 applies to new hires only. But also note the wording that you quoted "..is hired or within a reasonable time before compensation for the first pay period is currently available." Note in particular "is currently available". "Currently available" does not necessarily mean paid. An employee could be deemed as having "constructively received" earnings if it is available in a loan or advance etc. This might also apply if the employee has an opition to change pay day, such as from monthly to weekly during this "reasonable time".

To avoid the problems that could arise, is probably why plan elections are done before the period in which the earnings would be made. In other words if the election is made on January 15th, then it could be determined that the period January 1 to 14 must be excluded because the compensation has already been earned, it has just not yet been paid out. No different from the last paycheck or commission check, in companies that mail out their checks, which very often are not received until January 1 to 3, yet the amount is included is December earnings and on that prior year W2.

Other than a first time election, I would strongly advise that all elections be done before the period in which the compensation is earned. Waiting until so late in the month is too risky to be worth it.

If you can get to Notice 80-24 you will see that this is similar to the "Zero Balance" plans which were outlawed back in the 1970's but applied to your new hires.

[papogi]

I have read 2002-27. I don't think that the wording in the Rev Rul goes against the prospective requirement of 125. GBurns' point about "is currently available" is well taken, and I agree. The rev ruling doesn't say when the coverage is actually effective.