MERP

[Guest sterp]

I have an employer with 76 W-2 employees in a "C" Corp. 70 are highly compensated employees (HCEs). They have 6 additional W-2 employees are who are not highly compensated. They want to have the 6 do an FSA and the remaining 70 HCEs do a Medical Expense Reimbursement Plan (MERP). Each of the 70 HCEs fund their own MERP as they go ( if they have a reimbursable expense, the employer takes the amount of their paycheck on a pre-tax basis) and then reimburses them.

Is this kosher? If so, how? If not, why?

[J Simmons]

It should be no problem to limit FSAs to just the 6 lowest earning employees. That should fit within section 125 nondiscrimination and usage rules.

As you describe it, the nondiscrimination rules of sec 105h should not be a problem as the MERP would benefit at least 70% of the total 76 employees.

The problem is the part about the HCEs funding "their own MERP as they go ( if they have a reimbursable expense, the employer takes the amount of their paycheck on a pre-tax basis) and then reimburses them." That's closer to being an FSA than a MERP--MERPs are employer-only dollars and to the extent not used, the benefits do not enhance pay the employee receives--which is what you have described. That means you'd be governed by 125, and you'd have problems. One is that the key employees (a subset of HCEs) may have no more than 25% of the total tax-free benefits of all employees. If the employer is owned by, say, just a handful of those 70 HCEs, then this wouldn't be a problem.

There are new nondiscrimination rules that take effect 1/1/2009, and those would likely be a problem.

However, another problem with the MERP that smacks of a disqualified FSA is that the amount of an FSA for a plan year must be elected in advance of the plan year beginning, be taken out of paychecks ratably over the year (regardless of medical expenses being incurred). If the employee does not incur enough expenses during the year (and if designed in, the next 2 1/2 months) to exhaust the FSA through reimbursements, the employee forfeits the unused amount.

[GBurns]

What you describe seems to be the same as what used to be called ZEBRAs (zero balance reimbursement accounts) which were outlawed around 1984.

You might want to Google "zero balance cafeteria plans" to get some other comments.