"Deemed 125 Compensation"

Curious as to how many Plans you either service, or see, that use the option to INCLUDE Deemed 125 Compensation.

I remember discussing this with a noted ERISA attorney many years ago, - I think it was in regard to restating for PPA - and to paraphrase what he said, was that if you include it you'll probably live to regret it. Very complicated for clients and TPA's alike.

I've seen some old discussions on this, but I wondered how people felt about it now, years later.

I know this isn't really what you're asking, but from the health plan side I view this as a red herring.  The deemed 125 compensation issue addresses employers that condition the cash option on proof of other coverage, which then puts you outside the cafeteria plan safe harbor from constructive receipt.  I almost never see that approach in practice.

For one, the ACA employer mandate rules require that employees have an effective opportunity to decline the employer’s offer of coverage.  If the plan does not follow the federal poverty line safe harbor for determining affordability, there is an argument that the employee does not have the effective opportunity to decline coverage if they must show proof of other coverage.

Furthermore, requiring proof of other coverage raises potential state wage withholding law violations.  Employers generally cannot withhold amounts from an employee’s paycheck (including premium contributions) without the employee’s authorization.  Requiring proof of other coverage to decline the employer’s offer of coverage effectively compels employees without other coverage to pay the employee-share of the premium. 

It is very common for employers to require proof of other coverage to receive the opt-out credit, but that's a different situation that doesn't create deemed 125 compensation.  That's an affordability requirement to meet the ACA employer mandate definition of an "eligible opt-out arrangement."

Treas. Reg. § 54.4980H-4(b)(1):

(b) Offer of coverage—(1) In general. An applicable large employer member will not be treated as having made an offer of coverage to a full-time employee for a plan year if the employee does not have an effective opportunity to elect to enroll in the coverage at least once with respect to the plan year, or does not have an effective opportunity to decline to enroll if the coverage offered does not provide minimum value or requires an employee contribution for any calendar month of more than 9.5 percent of a monthly amount determined as the federal poverty line for a single individual for the applicable calendar year, divided by 12. For this purpose, the applicable federal poverty line is the federal poverty line for the 48 contiguous states and the District of Columbia. Whether an employee has an effective opportunity to enroll or to decline to enroll is determined based on all the relevant facts and circumstances, including adequacy of notice of the availability of the offer of coverage, the period of time during which acceptance of the offer of coverage may be made, and any other conditions on the offer. An employee's election of coverage from a prior year that continues for the next plan year unless the employee affirmatively elects to opt out of the plan constitutes an offer of coverage for purposes of section 4980H.

15 hours ago, Brian Gilmore said:

The deemed 125 compensation issue addresses employers that condition the cash option on proof of other coverage, which then puts you outside the cafeteria plan safe harbor from constructive receipt.  I almost never see that approach in practice.

15 hours ago, Brian Gilmore said:

It is very common for employers to require proof of other coverage to receive the opt-out credit, but that's a different situation that doesn't create deemed 125 compensation. 

Hi Brian - thanks for the response. But, I'm having trouble reconciling the above two statements - and please pardon my lack of understanding on this subject! Does the second statement mean an opt-out credit that is NOT cash - in other words, just used as cafeteria dollars to be used for other benefits under the plan - vision, dental, whatever?

I hear you.  So the issue here derives from Rev. Rul. 2002-27, addressing the basic premise of the Section 125 cafeteria plan safe harbor from constructive receipt.  Much like the CODA rules on the 401(k) side, these are designed to ensure employees won't be taxed on the value of the taxable cash option they could have received if they hadn't elected the health plan.  For the cafeteria plan rules to apply, the employee must have the choice between the qualified benefit and the taxable cash.

Assume your health plan premium is $500.  The ER contributes $350, the EE pays $150.  The employee can pay that $150 EE-share of the premium pre-tax by utilizing the Section 125 cafeteria plan (POP component) and thereby avoiding constructive receipt of the $150 cash option.

Now assume you can only waive the health plan if you certify other health coverage.  According to the IRS, this does not effectively provide the employee with a choice for the $150 cash option, and therefore we're operating outside of the cafeteria plan world.  So the $150 would be "deemed 125 compensation" for 415 comp purposes.  Per my note above, my argument is that this situation doesn't really occur in practice.

Now go back and assume we're back at the first example--no certification, cafeteria plan does apply.  Only difference is the employee offers an opt-out credit of $100 if the employee declines the plan.  In that case, the employee still has the unrestricted choice between applying the $150 to the health plan premium or taking the $150 as taxable cash.  The difference is that if the employee declines the health plan option, the employee now has $250 in taxable cash (the $150 not applied to the health plan, plus the $100 opt-out credit).

Any condition the employer imposes on the $100 opt-out credit (including the common requirement to certify other group coverage to satisfy the ACA employer mandate affordability requirement by meeting the "eligible opt-out arrangement requirements) does not affect the choice the employee had to take the $150 as taxable cash.  So we're not in a "deemed 125 compensation" situation there--the $150 is still squarely within the cafeteria plan.

Thanks! I'll digest this on Monday - after hopefully recharging a few brain cells. Have a great weekend!

Rev. Ruling 2002-27 said that the participant's cafeteria plan right to elect to receive cash instead of medical benefits was effectively impinged upon (by requiring them to certify they have other group health coverage) - and that practice effectively converted the amount that would have been an elective deferral under 125 (that would have been includible in comp under section 415) into an employer-paid medical premium that was excludible from comp under section 415 (as employer provided medical coverage excludible under section 106(a)) - but only for those who didn't or couldn't certify their ability to receive other coverage).  This was a messy and somewhat inequitable result - because the amounts that would have been paid toward the employee's portion of medical coverage for some people was 415 compensation (who certified that they had other coverage) but was not 415 compensation for others (who didn't and couldn't certify they had other coverage).     

The ruling probably was issued in 2002 because some employer had adopted this practice and treated the amounts that the employee wasn't allowed to elect to receive in cash as elective contributions under 125 (and thus includible in 415(c) pay) and was looking for a way to include these amounts in 415 pay (to avoid some sort of retirement plan qualification failure).  The issue probably came up when an employer submitted a plan for a determination letter for GUST (when section 415 pay definitions were required to be amended to include elective deferrals under section 402(e)(3) and 125 for the first time - starting in 1998). I think the upshot of the ruling was that even though the plan in question shouldn't have included the amount that they mistakenly included in comp as if they were still section 125 elective deferrals, IRS gave them relief by saying they could treat such amounts as if they were section 125 deferrals (even though they were really employer contributions excluded from income under section 106, not section 125 elective deferrals). 

I still see some plans that include deemed 125 comp in their plan documents. Nowadays, employees can go to the ACA marketplace and get access to coverage going forward without pre-existing condition exclusions. Now employers seem to be more concerned about meeting the ACA employer mandate (and offering affordable coverage to enough employees) than they are about paternalistic concerns about employees opting out of employer sponsored coverage and then not being able to get coverage outside of the employer plan.  

Mostly, those who still have deemed 125 comp in their plan documents probably don't still carry on the practice of requiring proof of other other group health coverage for employees to opt out of employee only coverage to receive cash (or taxable benefits) from their cafeteria plans, but since they are a pension plan (and they need to look at pay over the employee's career), they did so at one time and still include the deemed 125 comp in their pension plan's pay definitions for the period back when they used to do it.