Midyear change in election allowed without a qualifying event

[Guest kimb]

A client just notified us that 2 of her employees dropped their health insurance coverage because they couldn't afford the premiums anymore. They have a calendar year Cafeteria Plan and the change in elections were allowed in August.

How do we correct this mistake?? The employees no longer have the insurance and the withholdings were stopped in August.

[J Simmons]

I don't know that you can 'correct' it in the sense that the EPCRS specifies corrections for 401(a) plan problems. That is, there is not a comparable for cafeteria plan problems to the EPCRS for qualified retirement plan problems.

This failure could jeopardize the tax free status for the plan year of all benefits under the cafeteria plan.

However, if you thought that taking some remedial action is better than just hoping the problem is not picked up on audit, then you might consider some of the same fix-it principles from the EPCRS. The first of which is to take steps that will put the employees in the same (or closest possible) situation that they would have been but for the error.

You could perhaps hold out of their pay for December the amount that would have been over the 4-5 months since it was stopped in August, and get their insurance coverage reinstated. Both will face problems. There might not be enough December pay to go to make up for that much in insurance premiums. Also, you'd want to make sure the insurance company is on board with reinstating the insurance coverage retroactively. Not much of an upside to the insurance company to do so, but a big downside if there have been significant medical expenses incurred or medical conditions arise.

[Guest kimb]

Thanks for your reply. We ended up getting an "unofficial" opinion from the IRS and it made all parties involved happy!

[GBurns]

Would you be kind enough to share with us the details of the IRS opinion?

[Guest kimb]

Basically he said due to the economical state everyone is in right now he would have a hard time with someone having to pay back all that money at this time. He said if the plan is ever faced with an audit he doubts the IRS would penalize the plan for this as long as there is documentation in the 2009 files that explains what happened, why it happened, and the steps the company has taken to prevent this from happening again. In the documentation we suggested they put ".....due to the potential hardship on the employees, and it was not at any fault of theirs, we have decided to allow the changes to remain as is and have now initiated steps to be taken before a mid-year change in election is allowed under the Cafeteria Plan. ...."

I didn't mention in my original post, but this was the fault of the employer because she thought if the insurance would allow the mid-year change then so would the Cafeteria Plan (she's fairly new at this).

I strongly suggest if anyone is faced with a sticky situation like this one to call an IRS representative and get their professional advice on how to handle it. Your situation may be completely different than ours so I do not suggest you follow the same advice they gave us.

[Chaz]

Thanks for the post Kimb. That was a very interesting response from the IRS. As you probably know, unfortunately, "sticky situations" like this happen all the time.

[J Simmons]

Basically he said due to the economical state everyone is in right now he would have a hard time with someone having to pay back all that money at this time. He said if the plan is ever faced with an audit he doubts the IRS would penalize the plan for this as long as there is documentation in the 2009 files that explains what happened, why it happened, and the steps the company has taken to prevent this from happening again. In the documentation we suggested they put ".....due to the potential hardship on the employees, and it was not at any fault of theirs, we have decided to allow the changes to remain as is and have now initiated steps to be taken before a mid-year change in election is allowed under the Cafeteria Plan. ...."

I didn't mention in my original post, but this was the fault of the employer because she thought if the insurance would allow the mid-year change then so would the Cafeteria Plan (she's fairly new at this).

I strongly suggest if anyone is faced with a sticky situation like this one to call an IRS representative and get their professional advice on how to handle it. Your situation may be completely different than ours so I do not suggest you follow the same advice they gave us.

kimb,

Did the IRS employee put this response in writing, sign it and send it to you?

[Guest jackmo]

The procedures outlined by the IRS and the employer basically follow a "Plan of Self Correction".