Dropping COBRA FSA

Situation

Employee terminates with an underspent HCFSA and is offered FSA COBRA.  Employee pays COBRA premium for 2 months, exhausts the annual FSA balance during this time and wants to terminate COBRA premium after 2 months of COBRA.  Is there anything stopping the employee from doing this?  The COBRA administrator is claiming that if the participant fails to continue payments through the end of the year, any claims paid above what was contributed should be retroactively denied?

Thoughts?

FYI, COBRA admin is different than FSA admin, so I don't think the FSA admin would even find out, but curious to know what is correct.

I disagree with the TPA.  An overspent FSA when dropping COBRA is just like an overspent FSA when terminating employment.  The employer has no ability to recover that overspent amount.  It's just part of the risk-shifting aspect inherent to the health FSA structure (uniform coverage risk of overspent balances against use-it-or-lose-it risk of forfeitures) that can always lead to net experience gains or losses.

Employers cannot recover any amount from an employee who terminates employment mid-year with an overspent health FSA.  That would risk disqualifying the entire Section 125 cafeteria plan, resulting in all elections becoming taxable to all employees.  No different in the COBRA context.

In short, the employee has used COBRA appropriately for the health FSA and has played his cards well.  Just like if the employee had overspent the health FSA prior to termination (i.e., without the need for COBRA), the employer can't retro deny claims or do anything else to recover the overspent amount.

Note that the situation is a bit more murky when it's an active employee who tries to make an election change the reduces the election below the current YTD reimbursements, but that's not the situation here.  More details on that point here if you're interested:  https://www.newfront.com/blog/overspent-health-fsa-upon-termination-of-employment-life-event-2

Prop. Treas. Reg. §1.125-5:

(d) Uniform coverage rules applicable to health FSAs.

(1) Uniform coverage throughout coverage period—in general. The maximum amount of reimbursement from a health FSA must be available at all times during the period of coverage (properly reduced as of any particular time for prior reimbursements for the same period of coverage). Thus, the maximum amount of reimbursement at any particular time during the period of coverage cannot relate to the amount that has been contributed to the FSA at any particular time prior to the end of the plan year. Similarly, the payment schedule for the required amount for coverage under a health FSA may not be based on the rate or amount of covered claims incurred during the coverage period. Employees’ salary reduction payments must not be accelerated based on employees’ incurred claims and reimbursements.

IRS Chief Counsel Advice 201012060:

https://www.irs.gov/pub/irs-wd/1012060.pdf

The cafeteria plan rules require that a health FSA provide uniform coverage throughout the coverage period (which is the period when the employee is covered by the plan). See Proposed Treasury Regulations Section 1.125-5(d). Under the uniform coverage rules, the maximum amount of reimbursement from a health FSA must be available at all times during the coverage period. This means that the employee’s entire health FSA election is available from the first day of the plan year to reimburse qualified medical expenses incurred during the coverage period. The cafeteria plan may not, therefore, base its reimbursements to an employee on what that employee may have contributed up to any particular date, such as the date the employee is laid-off or terminated. Thus, if an employee’s reimbursements from the health FSA exceed his contributions to the health FSA at the time of lay-off or termination, the employer cannot recoup the difference from the employee.

Brian, thank you for confirming - much appreciated.

On 4/18/2024 at 10:19 AM, Brian Gilmore said:

An overspent FSA when dropping COBRA is just like an overspent COBRA when terminating employment.

Minor typo: 

An overspent FSA when dropping COBRA is just like an overspent FSA when terminating employment.