IRS Notice 2005-42; Grace periods for FSAs

[Guest David Lacy]

Anyone have any comments about IRS Notice 2005-42? Isn't this important news? Doesn't it help FSAs quite a bit in comparison to HRAs and HSAs?

[oriecat]

Sounds great!

[Guest Kim Flett]

I think this will increase flex participation. This is an optional provision and documents will need to be amended by the end of 2005 in order for it to be effective.

[Guest AHayhow]

Can you point me to a link where I can get a copy of it? I looked at irs.gov and couldn't find anythng.

[WDIK]

http://benefitslink.com/buzz/new.html

(Second item from the top for 5/18/2005)

[Alf]

I can't get too excited about this. They (Coingress if the IRS can't) should just reapeal the use it or lose it rule. Won't this just delay the closing out of annual administration now? If our run out period for substantiating claims was 2 1/2 months, we are just going to have to expand it to a 5 month run out now, right??

[oriecat]

Seems like you could extend the run out, but I don't see where you would have to...

[Guest jreddi]

My question would be: Does this create a "life status change" that allows employees to amend their 2005 elections to compensate for the grace period?

I can't find anything in the notice that addresses this.

Your thoughts?

John

[oriecat]

Why would they need to compensate for it?

Edit - but no, I don't see how this would qualify for making a change anyway.

[GBurns]

Does anyone know why these things are being released as "Notices" rather than as Revenue Rulings etc?

[Guest jreddi]

All very well and good about no "life status change". I can accept that.

But, on another point, since the plan year runs from January to December, how are we going to know against which plan year to use the funds? If an expense is incurred in February 2006, then is it against PY2005 or PY2006? And if the expense is used against 2005 and exhausts the FSA account (let's say, healthcare), then can the balance of the claim be reimbursed against 2006 election since it was incurred in 2006?

Maybe I am just being dense.

[oriecat]

I think those are good questions, jreddi. In my opinion, if there are still funds leftover from 2005, then it should be paid from 2005 first. If the point is to reduce forfeitures, then why would you use new funds before old? And since the expense would technically qualify in both plan years, it seems reasonable that the reimbursement could come from both years. Again, just my opinion.

[Guest msearle]

It's my understanding that you would use the first-in-first-out method. In other words, if a legitimate expense occurred during the 2 1/2 month time frame and prior year's FSA funds were still available, you would expend them first prior to using the current year's contributions.

But again, why was this issued as a notice? Is it effective like a rulinG?

[SLuskin]

Does anyone have an opinion on how this will affect employees who terminate midyear? Suppose that someone has made an election for $1200, makes $300 in payroll deductions, has claims of $500, and then terminates. Can the employer allow someone who has been employer the entire plan year and contributed the entire $1200 to extend the claims incurred period, but not allow this to the terminated employee? Thanks.

[g8r]

I don't think it would have any direct impact on terminees. Anyone who terminates is treated the same as when termination happened while there was a 12 month period of coverage. Most plans stop coverage on termination - then it's up to the individual to elect COBRA (if applicable).

I guess where this could get tricky is whether termination might entitle someone to a refund (and how that might affect the COBRA amount).

For example, I elect $1200. Do you take out $100/month or $1200/14 1/2 per month. If you take out $100/month and I quit mid-year, have you been accelerating payments so that I'm entitled to a refund (if coverage ceases on termination of employment). In other words, you're taking out $100/month and the actual cost is less than that because it should now be spread over 14 1/2 months, not 12 months. I can't imagine the IRS would take this position...but I don't know....

[oriecat]

I would think that's stretching a bit. It's still a plan year, a year is 12 months. The grace period isn't extending the plan year. It's just giving a grace period.

[smm]

To answer the original question, this was the ultimate dumb move. Instead of having amounts left at the end of the year, participants will have amounts left at the end of the 2 and 1/2 "grace" period. Participants will always have amounts left regardless of when the period ends. Look at Blockbuster video. Now instead of returning movies on the due date, people return them at the end of the 7 day grace period - or keep them longer and still end up with a "late" fee (oops, I forgot, there are no more late fees!!!!!!!!)

[jevd]

But thats not a late fee. It was explained to me as a re-stocking fee???

Try screaming a bit. It worked for me.

[smm]

Same result. Just like amounts that will be left in a 125 plan. My advice to clients - don't waste your time and money with the amendment. So far, they agree!

[Guest DK Ellerson]

I think that, once again, the IRS in it's infinite wisdom has tried to be helpful but just wound up wreaking havoc from an adminstrative standpoint. The actual notice itself cites an example of a claim incurred in the CY of $300. CY annual election is $1500, PY account has $200 left in it. The $200 from last year is used first, and the remaining balance comes from the CY account. I can see accounting departments going berserk. One claim submitted, funds from 2 different plan years, let's tag this here...track that there. Also, if an employer chooses to implement this option, we could theoretically still be administering run out claims through the month of May! ACK! I don't mean to be negative, but I think if employers really think this through, they may find themselves really glad that this ruling is optional. However, with more and more employees screaming for better benefits, this would definitely appear to be an attractive value-added benefit with minimal cost to the employer.

Has anyone tried to process a claim under the new scenario? We did a test run, and my flex program couldn't understand how I could possibly pay a claim in the prior year with a current year service date, so it just didn't pay it. I'm hoping my software vendor comes up with a fix.

[SLuskin]

Our software vendor has promised a fix by June 30.

My clients are asking for the amendment. Attorney wants to charge an arm and a leg. Does anyone have some suggested wording that won't cost $3000?

[Guest Robin S. Vatalaro]

Not answering the previous post, but a new question:

Latest ASPA ASAP says that if this new option is elected by a plan sponsor, then claims occurring in the first 2 1/2 months of a new plan year "will" be applied to the previous plan year. Does "will" mean "must?"

So let's assume that my FSA through Ford Motor, which happens to have a 5/31 YE, has made this election (I doubt it, but let's just suppose). I have scheduled an eye exam at DOC Optical ("DOC") in early June, on purpose to have the cost fall into the FYE 5/31/06 plan year end.

I spend $300 and have planned for this, by having made an appropriate W-2 w/h election in 4/05 (Ford's deadline), for the upcoming FYE 5/31/06 plan year.

Since Ford has made the election to permit the 2 1/2 month extension (again hypotheical), am I FORCED to have my DOC costs apply to the FYE 5/31/05 plan?

My 5/31/05 FYE costs far exceeded the amount elected from paycheck for FYE 5/31/05.

So does that mean that I just lose my DOC bill? I intend and want to apply it to FYE 5/31/06 - sounds like maybe now I can't do that.

Am I overinterpreting?

Thanks for any help.

[oriecat]

Unless I am misunderstanding, an important piece is missing in your interpretation, the carried over funds. It sounds like you wouldn't have any carried over funds, since you said your expenses far exceeded your elected amount. Since you wouldn't have any carried over funds, your expenses would have to come from the new plan year election.

[Guest msearle]

Is this just a one time deal (2005 only) or is it a forever thing? Also, what if you only want to extend one and half months rather than the full two and a half that is allowed. I assume that is okay???? (I'm not saying it's a smart thing to do, but I just want to better understand the rule.

[Alf]

Not just for 2006 and yes, you can use less than 2.5.

[oriecat]

I don't think forever is ever a good word to use when it comes to the IRS.

[Kirk Maldonado]

oriecat:

That all depends on the context of which "forever" is used.

[Guest kjhgwh]

Our VP of HR asked when I would have a recommendation about this ruling.

I'm not convinced this ruling will be a benefit for our employees in the long run as the FSA providers will have their hands full with the administration between two calendar years' election amounts, thus delaying processing of claims, etc.

As we have until 12/31/05 to adopt the amendment, I want to wait and see how the FSA providers communicate how they are going to administrate.

Any thoughts on sitting tight until the Fall?

[Alf]

Aren't forfeitures just a sign of poor employee communications? I contend that proactive companies can do a lot to keep forfeitures to a minimum in the first place (during the original 12 months) and that should be the goal. This 2 1/2 extension is just a band-aid and companies would be better served to focus on disclosure and communication upfront at enrollment and on an ongoing basis during the year.

Will your VP of HR buy that?

[Guest kjhgwh]

I agree with you 100% that ongoing communications and education is the key!

Since we are have a January renewal date our VP agreed we have a couple of months to see how the various FSA carriers communicate the ground rules and procedures if a company chooses to amend its FSA plan.

[jsb]

We have taken the stance of seeking to administer our plans up to what is maximally permitted by the law. This avoids any questions about why our policies are more restrictive than the regs would allow, especially when our policy would work to the detriment of our employee, even if it is due to the employee's own bad planning. We hope this will help reduce forfeitures as well as encourage some folks who have been reluctant to join the plan to give it a try.

[Guest msearle]

If a plan year ends in July, if you want to adopt the new ruling in the plan, does it have to be incorporated this July, or is next July the deadline?

[WDIK]

The notice indicates the following:

"An employer may adopt a grace period as authorized in this notice for the

current cafeteria plan year (and subsequent cafeteria plan years) by amending

the cafeteria plan document before the end of the current plan year." (emphasis added)

[Guest Admiin]

New Question:

I haven't heard anything about the current 90 day grace period. Does anyone know...if we do adopt the new 2-1/2 month extention for our clients do they then get the other 1/2 of a month to turn in claims? Ex. Dec. 31st PYE currently get until March 31st with extention they get until March 15th. Or is the PY ended on March 15? Or do we have to add the 90 days to the end of the 2-1/2 months??

In general, I am concerned about future curtailments by the IRS after this is up and running. There are too many questions yet to be answered by the "authority." But I do not want to be left behind in administration.

[oriecat]

The current 90 day period for submitting claims is not a grace period, but a runout period. If you decide to adopt the 2 1/2 month grace period for incurring claims, you can then extend your runout period for submitting them as well. That is up to the plan to decide if they want to do that.

[katieinny]

I want to get back to SLuskin's question. Is there going to be a canned amendment for employer's to adopt, or will they have to have someone draft one for them?

[Alf]

No canned amendment. The existing provisions of the plan will "just" have to be revised to extend the coverage period the desired amount. Also, decisions about how the run out is impacted and how terminated particiants run outs will be handled, etc. will have to be addressed.

[Guest sfranklin]

I attended a tele-web seminar on the New Use-it-or-Lose-it rule and this question was asked. The reply was that the plan year is still based on 12 months not 14 1/2. The grace period is what was extended.