Participation in Sec. 125 by Terminated EE

[MARYMM]

Exec position is eliminated and the ee is to be given severance payments for a 1 year period. Exec is allowed to continue on health insurance. I don't question that part since the health ins. carrier can create a new class of eligible participants.

What I am uncomfortable with is that the exec is being allowed to do 2 things thru the Sec. 125 Plan -

1. pay for the health insurance on a pre-tax basis

2. make pre-tax contributions to the FSA (medical reimbursement) plan

I am reading the plan docs (POP and FSA) and see that "employees" are eligible to participate and "employee" is defined as an individual whose customary employment is at least 24 hours per week. I tend to read things literally, so I would say that a terminated person is not eligible since they are not working 24 hours per week. On the other hand, neither is someone who is on a paid LOA. Another point of view that has been expressed is that as long as the individual is receiving severance pay they are an employee.

Can anyone point me to regs. that would prove/disprove my theory that this exec should not have been allowed to continue Sec. 125 participation ?

Thanks

[QDROphile]

The plan terms need to fit better. Someone needs to evaluate application of discrimination rules, especially with respect to the health FSA.

[MARYMM]

The plan terms need to fit better. Someone needs to evaluate application of discrimination rules, especially with respect to the health FSA.

I was concerned about discrimination too since we have another former ee on severance pay for a protracted period and that ee was not allowed to continue FSA participation

[leevena]

I am uncomfortable with the scenario you explained, but that being said, I do not know enough of the specifics to comment confidently.

To begin with, a Flexible Spending Account is not portable, and cannot be maintained for an ex-employee. Secondly, these plans are "payroll reduction plans", which indicate employement and compensation. So, if the employee is truly an "ex" employee, there is a problem.

Your last comment about receiving severence pay equates to being an employee may or may not be true. Was the employee terminated and then paid for one year? If this is true, then they are clearly not an employee. Or is the employee doing some kind of work for the employer in exchange for the one year salary? If this is the situation, there may be some legitimacy to the claim that they are still an employee. My guess is that the employee was severed completely and is receiving a payout.

[Don Levit]

Folks:

The Employee Plans CPE Technical Topics for 1998 provides an interesting perspective from the IRS.

On p. 6, it states, "The term 'employee' includes both present and former employees. In addition, the plan may not be established primarily for former employees."

Don Levit

[leevena]

Folks:

The Employee Plans CPE Technical Topics for 1998 provides an interesting perspective from the IRS.

On p. 6, it states, "The term 'employee' includes both present and former employees. In addition, the plan may not be established primarily for former employees."

Don Levit

Don:

I could not find the document you cited above, but I did find a tax publication that does not allow former employees to participate. It allows for three categories:

1. A current common-law employee (see section 2 in Publication 15, (Circular E), for more information).

2. A full-time life insurance agent who is a current statutory employee.

3. A leased employee who has provided services to you on a substantially full-time basis for at least a year if the services are performed under your primary direction or control.

As I mentioned in my reply, I am not 100% confident of my reply, so learning something new would be of help to me.

The link is as follows:

http://www.irs.gov/publications/p15b/ar02.html

[MARYMM]

I am uncomfortable with the scenario you explained, but that being said, I do not know enough of the specifics to comment confidently.

To begin with, a Flexible Spending Account is not portable, and cannot be maintained for an ex-employee. Secondly, these plans are "payroll reduction plans", which indicate employement and compensation. So, if the employee is truly an "ex" employee, there is a problem.

Your last comment about receiving severence pay equates to being an employee may or may not be true. Was the employee terminated and then paid for one year? If this is true, then they are clearly not an employee. Or is the employee doing some kind of work for the employer in exchange for the one year salary? If this is the situation, there may be some legitimacy to the claim that they are still an employee. My guess is that the employee was severed completely and is receiving a payout.

I appreciate everyone's comments on this.

You are correct - it is a payout. I have a copy of the Severance and Settlement Agreement. There is compensation - but no service. Employment was terminated in fall 2006 but the ee has 12 months of salary continuation. The agreement discusses the continuation of medical/dental coverage and that the er will pay towards it what would be paid for an active ee's coverage. It is silent on how the term'd ee is to pay his share . Also no mention of continuing in the FSA.

I also see this : "employer intends that the severance payments under subsections... constitute benefits provided under a "Welfare Plan" under ERISA..and any ambiguities in this Agreement shall be construed to effect that intent".

[MARYMM]

Folks:

The Employee Plans CPE Technical Topics for 1998 provides an interesting perspective from the IRS.

On p. 6, it states, "The term 'employee' includes both present and former employees. In addition, the plan may not be established primarily for former employees."

Don Levit

Don:

I could not find the document you cited above, but I did find a tax publication that does not allow former employees to participate. It allows for three categories:

1. A current common-law employee (see section 2 in Publication 15, (Circular E), for more information).

2. A full-time life insurance agent who is a current statutory employee.

3. A leased employee who has provided services to you on a substantially full-time basis for at least a year if the services are performed under your primary direction or control.

As I mentioned in my reply, I am not 100% confident of my reply, so learning something new would be of help to me.

The link is as follows:

http://www.irs.gov/publications/p15b/ar02.html

Thanks! That is exactly what I was looking for. Your link did not work but it did point me to Pub. 15B - maybe this one will work http://www.irs.gov/pub/irs-pdf/p15b.pdf

[J Simmons]

Don:

I could not find the document you cited above, but I did find a tax publication that does not allow former employees to participate. It allows for three categories:

1. A current common-law employee (see section 2 in Publication 15, (Circular E), for more information).

2. A full-time life insurance agent who is a current statutory employee.

3. A leased employee who has provided services to you on a substantially full-time basis for at least a year if the services are performed under your primary direction or control.

As I mentioned in my reply, I am not 100% confident of my reply, so learning something new would be of help to me.

The link is as follows:

http://www.irs.gov/publications/p15b/ar02.html

Hi, Leevena,

You might check Treas Reg 1.125-1, Q&A-4, which in relevant part provides: "The term 'employees' includes present and former employees of the employer. All employees who are treated as employed by a single employer under subsections (b), ©, or (m) of section 414 are treated as employed by a single employer for purposes of section 125. The term "employees" does not, however, include self-employed individuals described in section 401© of the Code. Even though former employees generally are treated as employees, a cafeteria plan may not be established predominantly for the benefit of former employees of the employer."

[Don Levit]

John:

Bingo, you got it!

Don Levit

[leevena]

John and Don. Thanks for the reply. It is strange that the IRS document I found did not allow for ex-employees.

By the way, John, are you the John Simmons from Deland Fl?

[J Simmons]

Not from Deland, but in the early 80's I lived in Tallahassee and a little town north of Daytona Beach called Bunnell. Since then, out West.

[MARYMM]

John and Don. Thanks for the reply. It is strange that the IRS document I found did not allow for ex-employees.

I'm trying to reconcile these 2 contradictory pieces of info.

Could it be that , per the Q&A, ex-employees are "allowed to participate" in the sense that they can elect COBRA for the FSA (if eligible) or can submit claims for services incurred prior to termination ? They can still be participants even if they are ex-employees .

On the other hand, Pub. 15 B states "Current employees" are eligible to participate. Is that because the focus of that publication is on the pre-tax deduction and not the claiming of benetfit aspects of Sec. 125 Plans?

[J Simmons]

MARYMM:

I think you got that right.

[Guest devilliers]

Well this discussion here certainly made me aware of many facts that were not known to me earlier, however it would be of great help to me if someone can guide me with some links that can make me aware of the different health insurance plans and the taxes that have to go with it for my small organization which currently has around 12 employees.

[Don Levit]

devilliers:

Can you be a bit more specific what you are looking for?

What are you trying to accomplish via health insurance for your employees?

MaryMM and J Simmons:

Thanks for providing the link to Publication 15-B.

On p. 3, it states " Generally, a cafeteria plan does not include any plan that offers a benefit that defers pay. However, a cafeteria plan can include a qualified 401(k) plan as a benefit."

I am curious if contributions made to a VEBA would qualify under a cafeteria plan?

The VEBA can serve 2 purposes: (1) an insurer; (2) a way to accumulate savings for medical expenses.

I can see how premiums paid to the VEBA as an insurer would qualify under a cafeteria plan.

How would contributions to an individual's account for medical expenses fare under a cafeteria plan?

Is it deferred pay, if the expenses can be used only for medical care, and any unused balance is forfeited back to the VEBA?

Don Levit

[oriecat]

Ignore devilliers, it's a spam post.

[Don Levit]

oriecat:

You may be right about the spam.

I am curious how you, and others, may answer my question.

Should I post to the VEBA board?

Don Levit

[oriecat]

I don't know anything about VEBAs! Posting a separate thread is probably a good idea.