Do the "use it or lose it" rules of cafeteria plans violate

[Kirk Maldonado]

Has anybody had to address whether contributions to dependent care expense reimbursement account and medical care expense reimbursement account (that are part of a cafeteria plan) satisfy the requirements of the Service Contract Act?

The DOL is taking the position that because the participant will forfeit some or all of the amount in the account if the participant does not submit a sufficient amount of claims (pursuant to the "use it or lose it" rules of cafeteria plans), that violates the Service Contract Act.

The applicable regulation dealing with benefit plans in general (29 CFR Section 778.215) does not expressly mandate this result. Also, I think that it is significant that the regulation dealing with contributions to tax-qualified retirement plans (29 CFR Section 778.214) does not require that the contributions be fully vested immediately, only that the contributions be irrevocable.

Thus, it seems that as long as the forfeited amounts are required to remain in the cafeteria plan (e.g., used to increase benefits for all participants for subsequent years), the Service Contract Act should be satisfied.

Nevertheless, I can understand why the DOL is asserting its position.

Does anybody have any views on this matter?

[IRC401]

Would you please clarify what the DoL's position is and how they are raising it? Don't the regs that you are citing deal with wage and hour issues (which I normally don't deal with and talk to one of the labor attorneys in my firm when I need to deal with them)?

Is the DoL taking the position that amounts run through a 125 plan for dependent care don't count as wages for meeting overtime rules? minimum wage rules? something else? Is this issue arising in the context of union or non-union employees? employees earning at or near minimum wage?

Thank you.

[Kirk Maldonado]

IRC401:

The DoL is taking the position as a result of an audit. (The PWBA is not involved in the audit, to the extent of my knowledge. It is apparently being handled by another part of the Dol.)

They are raising a number of issues (not all of which have merit), including the fact that, if participants forfeit amounts (because they don't submit claims for the total amount in their reimbursement accounts), those participants must be made whole (by an additional payment from the employer to the participant). Needless to say, that could cause problems under the cafeteria plan rules.

Unfortunately, the regulations read as if they were written by a labor attorney, not a benefits attorney. Accordingly, they are ambiguous.

The issue relates to the Service Contract Act, which, as I understand it, requires that employers pay the "prevailing wage" to employees working on federal contracts. Because there could be a forfeiture of amounts in the account, that could cause the total amount paid to the employee to be less than the prevailing wage, so goes the argument of the DoL.

One factor that the DoL hasn't yet recognized is that, because the employees receive the reimbursements tax-free, they could forfeit a sizeable portion of their account balances and still end up with more after-tax dollars.

[IRC401]

Kirk-

You need to consult with an attorney who specializes in wage and hour issues. That is outside of my area of expertise, but I can't resist the opportunity to get my $.02 in.

The Dol's position does not sound ludicrous. (I didn't state that it was correct or good public policy.) If the DoL is correct, putting the cafeteria plan money into a trust shouldn't make a difference. The DoL should be concerned about what the employee receives, not the fact that the contributions remain in a trust.

I can think of two possible solutions. First, if the employee doesn't work all year on prevailing wage projects, make the dependent care elections apply only to non-prevailing wage work (although I suspect that it might be extremely difficult to administer such a program.)

Second, the employer can set up a welfare plan (with a trust) with defined contribution accounts to which it can make contributions that will cover any shortfall in prevailing wages. Contributions to this trust could be used to replace money lost under use it or lose it (but the contributions should be tied to prevailing wage rules, not to 125 plan forfeitures). There will be issues that need to be dealt with, but the concept should be workable if it is a big enough issue for the employer.

Thank you for alerting us to the DoL's enforcement activity.

[Linda]

Could you tell the DOL that the employee’s contributions bought coverage under the 125 plan? In other words, the employee has received coverage throughout the year, even if benefits actually disbursed were less than the cost of coverage.

[Kirk Maldonado]

Linda:

Creative and interesting theory. Unfortunately, I think that you would have trouble under ERISA justifying "purchasing" coverage when the maximum reimbursement is the amount of your premiums.

[Linda]

But isn't the maximum benefit the amount elected plus the tax savings?

[Kirk Maldonado]

Linda:

Again, you raise a good point.

However, my concern would be that the DOL would say that if you paid the amount to the employee directly, then the employee could decide if he or she wanted to contribute some or all of those amounts to the plan to effect the tax savings.

If the employee didn't anticipate incurring any expenses, then putting the money in the cafeteria plan does not confer any benefit (tax or otherwise) on the employee.

I don't want to seem argumentative; I'm just trying to find a waterproof argument. Obviously, I'm having some difficulty, or I wouldn't have posted this message.

[Bob R]

Kirk - I think Linda's argument will be sufficient. A health FSA is a self funded health plan (i.e., it's subject to IRC Section 105(h)). Other than that, it isn't different than any other type of health coverage. While it's true in most cases the maximum equals the premiums, that's not always the case.

For example, suppose the coverage is $1,200 per year. An employee who incurs $1,200 of expenses in January is entitled to a reimbursement of $1,200. That employee might only be working on a prevailing wage contract for January. Or the employee could just quit in February. The employer has assumed the risk. Of course the employee has a risk of loss if the employee is in the plan for the full year and doesn't incur expenses up to the maximum. But, based on the net cost to the employer for the year, it's possible that a higher "premium" could be charged if the employer wanted to do so. If the plan were funded, the rules under IRC Sections 419 and 419A permit a higher premium to be charged. Just because the employer doesn't charge a higher premium shouldn't be a factor.

Also, you could point out that the health FSA is no different than a typical indemnity policy when it comes to utilization (the use it or loose it issue). Providing health coverage through an insurance contract in order to satisfy the prevailing wage is acceptable to the DOL. What if the employee doesn't ever use the coverage? (maybe the employee has no medical expenses, a spouse has primary coverage, or like somone at our firm, an employee is still entitled to medical coverage through the government because he is a veteran). It's no different than the health FSA. An employer is providing coverage - whether an employee uses that coverage is irrelevant.

I haven't actually had this issue raised before. We have prepared numerous qualified plans that are designed to satisfy the prevailing wage laws (such as the Davis-Bacon Act), but all of them have provided for full vesting of the prevailing wage contribution.

[Kirk Maldonado]

Bob R:

Thank you for your thoughtful and insightful remarks.

You provided me with exactly the types of arguments I was looking to find. I sincerely appreciate your taking the time to give me (and all of the other readers) your input.