Abruptly End an FSA Plan Year and Start a New One Mid Year?

[Guest benecom]

I have a client that has asked to end the current FSA plan year (1/1 to 12/31), and start a new plan year on 7/1. Their Health Plan renewal is 7/1 and they are making significant changes to the Health plan that would cause hardship to those who have an FSA in progress that would not cover the new expenses, and also to those who need to implement an FSA for the new expenses.

I've read a ton of code that says this does not cause a Change of Election qualifying event, but doesn't necessarily cover guidance about ending the plan and starting over.

What are their options, if any?

Thank you in advance for your responses!

CJL

[SLuskin]

There is no way this is permissible.

I just worked on a similar situation with a client. We made them finish out the plan year. Then this year that started 1/1/2011, we had a short plan year until 7/31/2011. Their health plan renews August 1. The next plan year will be August 1, 2011 until July 31, 2012.

Obviously, if they don't get audited, they will have "gotten away with it". But you certainly don't want to encourage that decision in any way.

[oriecat]

So would it be fair to say that you can say you'll have a short plan year at the beginning of the year, but can't decide midway that you're making it a short year?

[Guest Sieve]

I agree with SLuskin that a cafe plan's plan year should only be changed when participants have been given a head's-up before electing their deferrals, so they know that this time they are deferring only for, say, a 6-month period. That's what I've always done--primarily out of fairness to the employees.

But, I'm not sure that's a requirement. Look at this example from Prop. Treas. Reg. Section 1.125-1(d)(4):

Example 2. Employer changes insurance carrier.

Employer H establishes a cafeteria plan effective January 1, 2009, with a calendar year plan year. The cafeteria plan offers an accident and health plan through Insurer X. In March 2010, Employer H contracts to provide accident and health insurance through another insurance company, Y. Y

'

s accident and health insurance is offered on a July 1

–

June 30 benefit year. Effective July 1, 2010, Employer H amends the plan to change to a July 1

–

June 30 plan year. Employer H has a business purpose for changing the cafeteria plan year and for the short plan year ending June 30, 2010.

In that case (the above example), I would at least amend the plan to provide for a grace period so emoloyees can use up the short year deferrals during the next 2-1/2 months.

[SLuskin]

I think things may have eased up for pop plans, but I think you would have a tough row to hoe in abruptly changing a flex plan mid year. You may have employees who would lose money in the changeover - employee "saving" for a root canal in September makes contributions Jan-July with no other expenses. If you terminate that plan and start a new one, the funds don't transfer over and that employee would lose the money.

Next scenario - employee uses entire annual election on day 1 for a valid expense. If the plan year finished out, the employer would be made whole. Now the employer will lose this money.