Uniform Coverage rule for non-125 FSA

[Guest Charlie Stevens]

I have a client that wants to set up a non-§125 FSA, i.e., no discretionary contributions are made by the employee; the employer will merely reimburse funds up to a limit. The employer, however, wants to make $750 dollars available every 6 months rather than have $1500 available at all times during the year. While this would run afoul of the $125 regs., I know of no reason why we can't have these terms in place for a non-§125 FSA. Does anyone see a problem with this?

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Charlie Stevens

Michael Best & Friedrich LLP

[Joe Priselac]

The arrangement you describe would be covered by section 105(h)and not Section 125. There is no legal requirement to stipulate an annual maximum. Think of a self-insured medical plan with unlimited major medical benefits as an example. As long as you follow the nondiscrimination rules for these types of plans, you should be able adopt these provisions.

[Guest Harry O]

The various FSA rules set out in Q&A 7 apply to *all* FSAs (as defined in Q&A 7©) REGARDLESS of whether the FSA is provided as part of a section 125 plan. See Q&A 7(a): "These rules apply to a health plan without regard to whether the plan is provided through a cafeteria plan." In other words, unless an FSA complies with the various requirements of Q&A 7 it won't be eligible for favorable tax treatment under sections 105 and 106.

Sorry for the bad news . . .

Now, these are only *proposed* regulations . . .

[Linda]

According to Prop. Reg. 1.125-2 Q&A-7, a FSA must exhibit the risk-shifting characteristics of insurance in order to qualify as a group health plan under 105 and 106. I could interpret that as prohibiting the carry-over of a FSA balance past the "period of coverage." But as far as the length of the period of coverage, I think a non-125 FSA has some flexibility as long as the period of coverage does not "eliminate all, or substantially all, risk of loss." While a FSA under a 125 plan cannot have a period of coverage of less than 12 months, I don't think the same absolute minimum would apply to a non-125 FSA. So, I think a non-FSA could have a six-month (rather than a 12-month) period of coverage. What do you think?

[Guest Charlie Stevens]

Linda,I am also familiar with the proposed regulation and I have a number of concerns.

First, the proposed reg. purports to govern cafeteria plans, so why should it be assumed to be relevant to the issue of whether a non-section-125 health plan discriminates in favor of highly compensated individuals?

Second, even if the proposed reg. is applicable in determining whether there is in fact "risk-shifting" what is magic about monthly payments as opposed to semi-annual payments? Even with semi-annual payments I do not see how this can be argued to eliminate "all or substantially all of the employer's risk."

Unfortunately, the employer is not so large nor the amounts in question so significant that it would willing take a position contrary to the anticipated position of the Internal Revenue Service. It would be a pyrrhic victory to eventually win in a battle with the IRS at a cost far exceeding the amounts in question.