Can an employee "overfund" his FSA when unused funds are being given to charity?

[Guest GWell]

I am on the board of a nonprofit organization, and we have spoken with a company about the possibility of having any unused FSA funds at plan year-end be given to us by the company. I know other companies do something like this with leftover funds, so I assume this is ok. The question I am trying to answer, however, is this: can employees

intentionally overfund their FSAs, knowing that any unused funds will come to my organization at the end of the plan year? This would allow them, in effect, to make a gift to us on a pretax basis.

Of course, the employee(s) would not receive a tax receipt from us (though the company, as the donor, would). And the company would not be legally bound to make the gift to us at year-end, though the employee would have a reasonable expectation that this would occur.

I wonder, has anyone ever heard of such a thing happening before? Do you think the IRS would frown on such a practice?

[GBurns]

I have never heard of such a scheme and doubt that anyone has done this with legal advice. I suggest that you ask 1 of these companies that are supposed to be doing this for the legal rationale and support.

Athough only proposed regs, the Treas Regs 1.125-1 and 1.125-2 are what most plans use as guidelines. As I see them the unused funds revert to the plan and plan participants, not to the employer. The plan is bound to operate for the benefit of the participants. Being the sponsoring employer is NOT the same as being the Plan.

Making this contribution would of no benefit to either the Plan or the participants, but would be as a charitable deduction to the employer. Something benefitting the employer would not be allowed the reversion of funds to the employer is not allowed.

[mbozek]

The employee will not be making a gift for charitable deduction puposes becuase the contributions are deducted from the employee's compensation. The employer will be eligible to claim a charitable contribution since the employer owns the funds. Excess FAS contributions are to be used to provide additonal benefits or reduce plan adm expenses. The employer could use the excess to pay plan admin expenses and contribute an equal amt to the charity. You need to consult a tax advisor to structure the arrangment properly.

[Guest GWell]

GBurns,

Thank you for your thoughts. If I understand your reply, you are questioning the very idea that unused FSA funds may be used for anything at all besides providing additional benefits to plan participants or reducing plan admin expenses (as mbozek mentions). I know Raytheon Corp has a policy of giving unused FSA funds to charity each year. I'm not sure how accessible their legal counsel would be to me, but I am assuming that a Forture 500 company would have not made such a decision without careful review.

I wonder if anyone else reading this forum knows of companies which have the practice of contributing unused FSA funds to charity? I did not understand the proposed Treasury Regs as providing a mandatory requirement that unused FSA funds be used to benefit the plan and plan participants. I had understood (perhaps wrongly) that this was a permissible option, not a mandatory one, and that once the funds reverted back to the employer, it regained full rights to the funds to use for any purpose whatsoever (other than, of course, refunding the money directly to the plan participants).

Any thoughts from others?

[Alf]

Raytheon does not contribute these to charities.

[GBurns]

Raytheon is a very accessible company so you might want to call Benefits Dept and ask if they really do this. Bear in mind that Raytheon has many operating divisions and subsidiaries so you will need to know more specifically the "Raytheon" that is allegedly doing this whether you call that unit or HO.

The unused funds revert to the Plan not the employer.

[g8r]

GBurns is correct. Under the old DOL tech release (I think it's 92-01), the funds belong to the plan and must be used for plan purposes. It's a DOL issue and that's why the IRS regs don't address this. The tech release provides that the DOL won't enforce the trust requirement (that FSA contributions be held in trust). But, it goes on to provide that all of the contributions are still plan assets.

But..... as a practical matter, when an FSA isn't funded, it's rather difficult to trace the funds. For example, assume the employer has been paying the costs of administering the FSA for the past umpteen years. I'd just state that those fees were paid with the FSA forfeitures and the employer is just recouping those expenses that it may have "advanced" to the plan. Thus, the forfeitures are just a reimbursement to the employer for the plan expenses - and the employer is taking those amounts and making a contribution out of it's own pocket b/c it's the right thing to do.

The key is that with unfunded FSAs (which is typically the case), it's very difficult to trace which shell the money is actually under (employer vs. FSA).

[GBurns]

On the contrary, I have always found it very easy to trace the funds.

The employee contributions are easily quantified from payoll records, the submitted claims are always recorded, the admin fees are set out in a contract and there is an audit trail for those payments. If there are employer contributions those are just as well documented. The rest is simple arithmetic.

[Guest GWell]

q8r,

Thank you for adding your comments. I am now convinced that GBurns is correct that the funds belong to the plan, not the employer (thank you, GBurns, for pointing this out).

I looked in a copy of the EBIA Cafeteria Plan manual and found the quote produced below. Judging from the quote, it sounds like some companies do in fact give the leftover amounts to charity, but it is not recommended in the manual. What I would like to know is, what practical impact is there regarding a violation of ERISA by engaging in such a practice? Do you have any idea? Clearly, there are companies that give the leftover to charity without much concern for a potential violation, but I wouldn't want to move forward unless I determined that it was more of a minor technical violation, and not a serious one.

Thanks so much to everyone who read and responded to my questions!

_________________________________

Contribute Experience Gains to Charity? Some plan sponsors design their health FSAs so that experience gains are paid to a specific charity or to charity in general. This approach would likely violate ERISA, since plan assets would not be used for the exclusive benefit of participants or to defray reasonable administrative expenses. Consequently, we do not recommend using this approach.*

* Plan sponsors that nonetheless take this aggressive approach should include a provision in the plan document that limits any amount paid to charity to an amount that can be justified as a reasonable administrative expense. The DOL is likely to be less concerned where only the plan sponsor forgoes the receipt of experience gains.

[Guest Pensions in Paradise]

I like your quote "I wouldn't want to move forward unless I determined that it was more of a minor technical violation, and not a serious one."

A mior violation, no matter how small, can quickly turn into a major headache.

[GBurns]

Let me warn you about "minor violations". Examiners have performance requirements which include productivity. Productivity can only be measured by number, complexity or size of cases handled. Cases have to resolved and the more in the examiners favor the better.

If you have an examiner who gets a case, What do you think that he will try to do if he sees that the issue that attracted attention is turning out to be minor? He has you on the hook, so he looks for leads to other issues. Since you have no idea what he will find, it is best to not have him attracted to you in the first place.

As Pensions in Paradise points out minor can become major.. and very easily.

[Guest smhjr]

I'm not the slightest bit of an expert on cafeteria plans, but the original quesiton was could a participant purposely overfund their FSA so that the excess went to charity at the end of the year. My question would be why would this be done? Two things come to mind.

My first thought is that the employer has not paid payroll taxes on that portion of the amount that was overfunded to the FSA. It sounds like a way for the employer to skirt paying some taxes.

Second would be if the individual has already maxxed out their charitable deductions for the year and could not take a current year deduction for the charitable contribution. By overfunding their FSA they are in essence receiving more of a current year charitable deduction then they are legally entitled to. Although I think very few people max out there charitable contributions each year.

Either of these situations could potentially be used as a scheme to avoid some tax payment. I would think it would be frowned upon. Otherwise why wouldn't the individual just follow the terms of the plan and then give money directly to the charity?

A lot of companies offer a charitable matching program to their employees and that seems like a better route to go for the employee, the employer, and the charity.

[mbozek]

The amounts contributed under a cafeteria plan are not considered to be subject to income or FICA tax because the employer never pays it to the employee.

Second, the maximum charitable deduction from income tax is 50% of Ajusted Gross income which very few taxpayers reach. Since the funds in queston are owned by the employer the transfer does not acure to the benfit of the employee.

The question of how excess funds can be disposed of revolves around who owns the excess contributions -the employer or the FSA plan since there is no trust.

[david rigby]

...the employer has not paid payroll taxes on that portion of the amount that was overfunded to the FSA. It sounds like a way for the employer to skirt paying some taxes.

Nor does the employee pay those taxes.

Bingo, this is the answer to why someone would want to do it.

[GBurns]

Maybe, but Who? Does the money belong to the employer, the employee or the Plan? What does the Plan and the Regs allow to be done with this money? Can anyone other than the "owner" of the money dispose of it in any manner they choose, even with permission of the "owner" and do so with no adverse consequences such as No tax deduction, no expense deduction, constructive receipt etc??

Those are much more important issues that have to be resolved, making the non-payment of FICA of not much importance.