State law v. Section 125

[Guest M Shaw]

Under state law, participation in group insurance by a state employee "shall be entirely voluntary at all times." Furthermore, "any employee may, upon any payday, withdraw from [the plan] upon giving the employer written notice and directing the discontinuance of deductions from wages."

How does this fit with the irrevocable election requirement of Section 125? Which controls -- state or federal law? Thanks for any assistance.

[Lisa Hand]

Which state?

[Guest M Shaw]

Florida. (Fla. Stat. § 112.11)

[Kirk Maldonado]

The DOL has issued at least one Advisory Opinion that state laws re payroll withholding are preempted.

[This message has been edited by Kirk Maldonado (edited 01-31-2000).]

[JWK]

As I understand the history of the proposed section 125 regs, the IRS tried to anticipate laws of this nature in Prop. Reg. 1.125-2, A-6(e), which states that a cafeteria plan may provide that a benefit will cease to be provided if an employee fails to make the required premium payment with respect to the benefit. Under these circumstances, the empoyee must not be allowed to make a new election for the rest of the plan year.

So, in a state that prohibits an employer from locking employees into a payroll withholding election for a full year, the employer can use this section of the regs to allow the election to be revoked without disqualifying the cafeteria plan. Note, however, that the benefit can no longer be provided, so this rule would not permit an employee to decrease coverage from family coverage to self-only coverage--he/she has to drop coverage entirely.

Also, as pointed out by Kirk Maldonado, the DOL has taken the position that state wage withholding laws are preempted.

[Kirk Maldonado]

Your information is based upon an earlier set of regs. The IRS has issued a subsequent set of regs for 125 plans.

[JWK]

I assume Mr. Maldonado refers to the 1997 temporary regulations. If so, his conclusion is incorrect for two reasons.

First, taxpayers can continue to rely on the proposed regulations pending issuance of further guidance from the IRS--even if the plan document has already been amended in accordance with the 1997 temporary regulations. See Announcement 98-105. So, even if the temporary regulations addressed the question raised by the questioner, my reference to the proposed regulations is valid.

Second, the temporary regulations do not address the cessation of contributions basis for mid-year coverage changes. The temporary regulations modify Q&A 6© and (d) of 1.125-2. Also, subsection (f) is withdrawn. The subsection I relied on, 1.125-2, A-6(e), is NOT affected by the temporary regulations. The IRS specifically stated that taxpayers can continue to rely on the existing proposed regulations concerning matters not addressed in the temporary regulations. Therefore, subsection (e) continues to be a valid basis for allowing mid-year changes in elections.

[Kirk Maldonado]

JWK:

I stand by my prior remarks. Although I will admit that I was focusing more upon termination of employment/rehire within the same plan year scenario.

You said "Under these circumstances, the employee must not be allowed to make a new election for the rest of the plan year."

You said that I was wrong because somebody could remain unde the prior version of the regulations. Of course that is true, but your prior statement was unequivocal that a person could not make a new election. That is wrong. If the employer switches to the new version, employees can make new elections. You didn't say that if the employer stays under the old rules no new election could be made; you said in no case could a new election be made.

This change was made because of the injustice that occurred under the prior regulations where an employee was (legitimately) let go and rehired in the same plan year. In such a case, the person could not make an election to pay insurance premiums with pre-tax dollars.

[JWK]

In the situation posited by the questioner, there wasn't a termination of employment. The questioner was asking how to reconcile a state law that requires an employee to be allowed to revoke a withholding election with the federal (section 125) rule that says a revocation (without some specified intervening event) is not permitted. Your comments regarding election changes following a termination of employment are interesting, but not responsive to the initial question.

Under the rule in question, 1.125-2, A-6(e), an employee CANNOT reenter the plan during the same plan year, regardless of whether the employer is operating under the proposed regs or the temporary regs. The temporary regs have no impact whatsoever on 6(e). So the new rule in the temporary regulations allowing re-entry mid-plan year is of no avail.

The harder question, in my mind, is how the 6(e) exception would work in practice. How do you communicate to employees that their elections are irrevocable except for this one-time opportunity to revoke? I guess you could say that you only get one pre-tax election and after that, you can make more elections but they're all based on after-tax contributions.

[This message has been edited by JWK (edited 01-31-2000).]

[Kirk Maldonado]

My position, which may involve different facts than as originally posited, is that if an employee terminates employment and is rehired in the same year, that employee can make a new election pursuant to the 1997 temporary regulations. Inasmuch as those regulations expressly allow changing of elections upon termination and/or commencement of employment, I think that those rules trump the langauge in the prior proposed regulations that you could not make a new election in the same plan year.

As to problem that the 1997 regulations do not expressly refer to (and supersede) the portion of the proposed regulation you cited, I personally submitted written comments to the IRS on this matter, asking them to remove this ambiguity when the regulation is finalized.

[This message has been edited by Kirk Maldonado (edited 02-01-2000).]

[Guest M Shaw]

Thanks for your responses and the lively discussion! I was aware of the DOL's position that state withholding laws are preempted by ERISA. However, since the Florida law refers to state employees (i.e., a government plan) I assume that this would not apply. My question really concerns any possible preemption by Section 125.

Since Prop. Reg. 1.125-2, A-6(e) has been interpreted to apply to situations such as this, does that mean that Section 125 does NOT trump conflicting state laws and an employee invoking such a state law must be allowed to drop his group coverage even in the absence of a valid status change?

[JWK]

No question that in the termination of employment scenario, a rehired employee can make new elections upon rehire, provided that the period of severance was at least 30 days and not a "sham". This is all extrapolated from Example 6 of the temporary regs and presumes a termination of employment.

My experience is that most state laws require an employee to authorize payroll withholding but do not require an employer to allow the employee to revoke that authorization at will. However, I understand there are a few states, Florida apparently being one of them, where the employee must be permitted to revoke an authorization at any time.

I'd explore a couple of things. First, can an employee be required to waive the revocation right as a condition of participation in the cafeteria plan? Under this approach, employees who refuse to waive still get benefits, but have to pay with after-tax dollars.

Second, if the right cannot be waived, is it permissible to allow an employee to revoke pre-tax withholding absent a recognized status change? To my knowledge, this is an uncommon use of 1.125 A-6(e) but is consistent with the intent of the drafters of the regulation.

Third, assuming you can rely on 6(e), what does this mean? The employee clearly can't resume participation on a pre-tax basis but is he also precluded from participating on an after-tax basis? Can the employee pick and choose which pre-tax benefits he keeps and which he discontinues?

It may be worth running this past someone at IRS.

[Kirk Maldonado]

ERISA preempts state laws because it expressly states so. However, I don't believe that the Internal Revenue Code does so. For example, in many instances, state law conflicts with the Internal Revenue Code (e.g., the tax treatment of employee contributions to a Section 125 or Section 401(k) plan).

[GBurns]

ERISA Section 1144 (a) Except as provided in subsection (B)...

Section 1144(B)2(A) Except as provided in subparagraph (B) nothing in this subchapter shall be construed to exempt or releive any person from any law of any State which regulates insurance, banking or securities.

To state that ERISA preempts state law because it says so is a misreading of ERISA. ERISA explicitly state WHEN and HOW it can , will or MIGHT preempt. Preemption is not an absolute. There have been many recent court cases in which the courts have ruled that State law is not preempted.

There is no conflict between State law and IRC regarding section 125. State law deals with State taxes, IRS deals with federal income tax. Not the same tax.