Cafeteria Plans

March 13, 2024

3510 / How are non-health-related benefits offered under a cafeteria plan affected by the Family and Medical Leave Act?

Under both the proposed and final regulations, employers are not required to continue an employees’ non-health benefits provided under a cafeteria plan (e.g., life insurance) during an FMLA leave. Rather, whether an employee is entitled to the continuation of non-health benefits must be decided under the employer’s policy applicable to employees on non-FMLA leave.<a href="#_ftn1" name="_ftnref1">1</a> <hr align="left" size="1" width="33%"><a href="#_ftnref1" name="_ftn1">1</a>. Treas. Reg. § 1.125-3, A-7.

March 13, 2024

3513 / Are amounts received under a cafeteria plan subject to Social Security and federal unemployment taxes?

Amounts received by participants, or their beneficiaries, under a cafeteria plan are not treated as wages. Thus, these amounts are not subject to tax under the Federal Insurance Contributions Act (FICA) or under the Federal Unemployment Tax Act (FUTA) if such payments would not be treated as wages without regard to the plan, and if it is reasonable to believe that IRC Section125 would not treat any wages as constructively received.<a href="#_ftn1" name="_ftnref1">1</a> <hr align="left" size="1" width="33%"><a href="#_ftnref1" name="_ftn1">1</a>. IRC §§ 3121(a)(5)(G), 3306(b)(5)(G).

March 13, 2024

3515 / What is a flexible spending arrangement?

A flexible spending arrangement (FSA) is a program under IRC Section125 under which incurred expenses may be reimbursed. This benefit may be provided as a stand-alone plan or as part of a traditional cafeteria plan. The most common types are health FSAs ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3516">3516</a>) and dependent care assistance FSAs ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3517">3517</a>). In order for the coverage provided through an FSA to qualify for the exclusion from income under IRC Sections 105 and 106 (for health FSAs, see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="332">332</a>, Q <a href="javascript:void(0)" class="accordion-cross-reference" id="334">334</a>) or IRC Section129 (for dependent care FSAs, see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3625">3625</a>), the FSA must meet the requirements set forth in Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3516">3516</a> and Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3517">3517</a>.

March 13, 2024

3518 / How are gains or income from a flexible spending arrangement treated?

Any gain or income from an FSA may be (1) used to reduce premiums for the following year; or (2) returned to the premium payors as dividends or premium refunds on a reasonable basis, but in no case based on their individual claims experience.<a href="#_ftn1" name="_ftnref1">1</a> The maximum amount of reimbursement for a period of coverage under an FSA may not be substantially in excess of the total “premium” for the coverage. The maximum amount of reimbursement is not considered to be substantially in excess of the total premium if the maximum amount is less than 500 percent of the premium. This definition is applicable to plan years beginning after December31, 1989.<a href="#_ftn2" name="_ftnref2">2</a> Since 2013, there are two possible plan options for a participant with unspent funds in a health FSA. The plan may (1) allow for a carryover of up to $500 to the next year, but forfeit amounts in excess of $500 ($640 in 2024, $610 in 2023 see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3516">3516</a> at year end; or (2) allow for a grace period giving participants up to an additional 2½ months (through March 15) to spend the unused funds, but forfeit any remaining at the end of the grace period. The employer can offer either option, but not both. Or it can offer neither option resulting in forfeiture of all unspent funds at end of year. <hr align="left" size="1" width="33%"><a href="#_ftnref1" name="_ftn1">1</a>. Prop. Treas. Reg. § 1.125-5(o). <a href="#_ftnref2" name="_ftn2">2</a>. Prop. Treas. Reg. § 1.125-5(a).

March 13, 2024

3502 / What benefits may be offered under a cafeteria plan?

Participants in a cafeteria plan may choose among two or more benefits consisting of cash and qualified benefits.<a href="#_ftn1" name="_ftnref1">1</a> A cash benefit includes not only cash, but a benefit that may be purchased with after-tax dollars or the value of which is generally treated as taxable compensation to the employee (provided the benefit does not defer receipt of compensation).<a href="#_ftn2" name="_ftnref2">2</a> A qualified benefit is a benefit that is not includable in the gross income of the employee because of an express statutory exclusion and that does not defer receipt of compensation. Contributions to Archer Medical Savings Accounts ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="422">422</a>), qualified scholarships, educational assistance programs, or excludable fringe benefits are not qualified benefits. No product that is advertised, marketed, or offered as long-term care insurance is a qualified benefit.<a href="#_ftn3" name="_ftnref3">3</a> With respect to insurance benefits, such as those provided under accident and health plans and group term life insurance plans, the benefit is the coverage under the plan. Accident and health benefits are qualified benefits to the extent that coverage is excludable under IRC Section106.<a href="#_ftn4" name="_ftnref4">4</a> Accidental death coverage offered in a cafeteria plan under an individual accident insurance policy is excludable from the employee’s income under IRC Section106.<a href="#_ftn5" name="_ftnref5">5</a> A cafeteria plan can offer group term life insurance coverage on employees participating in the plan. Coverage that is includable in income only because it exceeds the $50,000 excludable limit under IRC Section79 also may be offered in a cafeteria plan.<a href="#_ftn6" name="_ftnref6">6</a> The application of IRC Section79 to group term life insurance and IRC Section106 to accident or health benefits is explained in Q <a href="javascript:void(0)" class="accordion-cross-reference" id="240">240</a> to Q <a href="javascript:void(0)" class="accordion-cross-reference" id="249">249</a> and Q <a href="javascript:void(0)" class="accordion-cross-reference" id="8789">8789</a>. Accident and health coverage, group term life insurance coverage, and benefits under a dependent care assistance program remain “qualified” even if they must be included in income because a nondiscrimination requirement has been violated.<a href="#_ftn7" name="_ftnref7">7</a> (See Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3625">3625</a>.) Health coverage and dependent care assistance under flexible spending arrangements (FSAs) are qualified benefits if they meet the requirements explained in Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3515">3515</a>. For taxable years beginning after December 31, 2012, a health FSA offered through a cafeteria plan will not be treated as a qualified benefit unless the plan provides that an employee may not elect for any taxable year to have salary reduction contributions in excess of $3,200 in 2024 ($3,050 in 2023). made to such arrangement.<a href="#_ftn8" name="_ftnref8">8</a> See Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3501">3501</a>. A cafeteria plan generally cannot provide for deferred compensation, permit participants to carry over unused benefits or contributions from one plan year to another, or permit participants to purchase a benefit that will be provided in a subsequent plan year. A cafeteria plan, however, may permit a participant in a profit sharing, stock bonus, or rural cooperative plan that has a qualified cash or deferred arrangement to elect to have the employer contribute on the employee’s behalf to the plan ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3753">3753</a>).<a href="#_ftn9" name="_ftnref9">9</a> After-tax employee contributions to a qualified plan subject to IRC Section401(m) ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3804">3804</a>) are permissible under a cafeteria plan, even if matching contributions are made by the employer.<a href="#_ftn10" name="_ftnref10">10</a> FSAs may allow a grace period of no more than 2½ months following the end of the plan year for participants to incur and submit expenses for reimbursement ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3515">3515</a>).<a href="#_ftn11" name="_ftnref11">11</a> FSAs may now be amended so that $500 of unused amounts ($640 in 2024, $610 in 2023, $570 in 2022 and $550 in 2021) remaining at the end of the plan year may be carried forward to the next plan year. However, plans that incorporate the carry forward provision may not also offer the 2½ month grace period.<a href="#_ftn12" name="_ftnref12">12</a> A cafeteria plan also may permit a participant to elect to have the employer contribute to a health savings account (HSA) on the participant’s behalf ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="390">390</a>).<a href="#_ftn13" name="_ftnref13">13</a> Unused balances in HSAs funded through a cafeteria plan may be carried over from one plan year to another. Under the general rule, life, health, disability, or long-term care insurance with an investment feature, such as whole life insurance, or an arrangement that reimburses premium payments for other accident or health coverage extending beyond the end of the plan year cannot be purchased.<a href="#_ftn14" name="_ftnref14">14</a> Supplemental health insurance policies that provide coverage for cancer and other specific diseases do not result in the deferral of compensation and are properly considered accident and health benefits under IRC Section106.<a href="#_ftn15" name="_ftnref15">15</a> A cafeteria plan maintained by an educational organization described in IRC Section170(b)(1)(A)(ii) (i.e., one with a regular curriculum and an on-site faculty and student body) can allow participants to elect postretirement term life insurance coverage. The postretirement life insurance coverage must be fully paid up on retirement and must not have a cash surrender value at any time. Postretirement life insurance coverage meeting these conditions will be treated as group term life insurance under IRC Section79.<a href="#_ftn16" name="_ftnref16">16</a> To provide tax favored benefits to highly compensated employees and “key employees,” a cafeteria plan must meet certain nondiscrimination requirements and avoid concentration of benefits in key employees ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3504">3504</a>). The Affordable Care Act requires plans and issuers that offer dependent coverage to make the coverage available until a child reaches the age of 26.<a href="#_ftn17" name="_ftnref17">17</a> To implement the expanded coverage, the ACA allows employers with cafeteria plans to permit employees to immediately make pre-tax salary reduction contributions to provide coverage for children under age 27, even if the cafeteria plan has not yet been amended to cover these individuals. Both married and unmarried children qualify for this coverage. This rule applies to all plans in the individual market and to new employer plans. It also applies to existing employer plans unless the adult child has another offer of employer-based coverage. Beginning in 2014, children up to age 26 can stay on their parent’s employer plan even if they have another offer of coverage through an employer. Employees are eligible for the new tax benefit from March30, 2010 forward if the children are already covered under the employer’s plan or are added to the employer’s plan at any time. For this purpose, a child includes a son, daughter, stepchild, adopted child, or eligible foster child. This “up to age 26” standard replaces the lower age limits that applied under prior tax law, as well as the requirement that a child generally qualify as a dependent for tax purposes. <hr align="left" size="1" width="33%"><a href="#_ftnref1" name="_ftn1">1</a>. IRC § 125(d)(1)(B). <a href="#_ftnref2" name="_ftn2">2</a>. Prop. Treas. Reg. § 1.125-1(a)(2). <a href="#_ftnref3" name="_ftn3">3</a>. IRC § 125(f); Prop. Treas. Reg. §1.125-1(q). <a href="#_ftnref4" name="_ftn4">4</a>. Prop. Treas. Reg. § 1.125-1(h)(2). <a href="#_ftnref5" name="_ftn5">5</a>. Let. Ruls. 8801015, 8922048. <a href="#_ftnref6" name="_ftn6">6</a>. Prop. Treas. Reg. § 1.125-1(k). <a href="#_ftnref7" name="_ftn7">7</a>. IRC § 129(d); Prop. Treas. Reg. § 1.125-1(b)(2). <a href="#_ftnref8" name="_ftn8">8</a>. IRC § 125(i); Rev. Proc. 2019-44, Rev. Proc. 2020-45, Rev. Proc. 2021-45, Rev. Proc. 2022-38. <a href="#_ftnref9" name="_ftn9">9</a>. IRC § 125(d)(2). <a href="#_ftnref10" name="_ftn10">10</a>. Prop. Treas. Reg. § 1.125-1(o)(3)(ii). <a href="#_ftnref11" name="_ftn11">11</a>. Prop. Treas. Reg. § 1.125-1(e); Notice 2005-42, 2005-1 CB 1204. <a href="#_ftnref12" name="_ftn12">12</a>. Notice 2013-71, 2013-47 IRB 532. <a href="#_ftnref13" name="_ftn13">13</a>. IRC § 125(d)(2)(D). <a href="#_ftnref14" name="_ftn14">14</a>. Prop. Treas. Reg. § 1.125-1(p)(1)(ii). <a href="#_ftnref15" name="_ftn15">15</a>. TAM 199936046. <a href="#_ftnref16" name="_ftn16">16</a>. IRC § 125(d)(2)(C). <a href="#_ftnref17" name="_ftn17">17</a>. See IRC § 105(b); Notice 2010-38.

March 13, 2024

3504 / What nondiscrimination requirements apply to cafeteria plans?

If a cafeteria plan discriminates in favor of highly compensated individuals as to eligibility to participate or discriminates in favor of highly compensated participants as to contributions or benefits, highly compensated participants will be considered in constructive receipt of the available cash benefit.<a href="#_ftn1" name="_ftnref1">1</a> “Highly compensated” individuals are officers, shareholders owning more than 5 percent of the voting power or value of all classes of stock, those who are “highly compensated,” and any of their spouses or dependents. For this purpose, “highly compensated” means any individual or participant who, for the preceding plan year (or the current plan year in the case of the first year of employment), had compensation from the employer in excess of the compensation amount specified in IRC Section 414(q)(1)(B) ($155,000 in 2024, $150,000 in 2023, $135,000 in 2022, and $130,000 in 2020 and 2021), and, if elected by the employer, also was in the top-paid group of employees (determined by reference to Section 414(q)(3)) for such preceding plan year (or for the current plan year in the case of the first year of employment).<a href="#_ftn2" name="_ftnref2">2</a> Participation will be nondiscriminatory if (1) it benefits a classification of employees found by the Secretary of Treasury not to discriminate in favor of employees who are officers, shareholders, or highly compensated, (2) no more than three years of employment are required for participation and the employment requirement for each employee is the same, and (3) eligible employees begin participation by the first day of the first plan year after the employment requirement is satisfied.<a href="#_ftn3" name="_ftnref3">3</a> According to proposed regulations, a cafeteria plan does not discriminate in favor of highly compensated individuals if the plan benefits a group of employees who qualify under a reasonable classification established by the employer and the group of employees included in the classification satisfies the safe harbor percentage test or the unsafe harbor percentage test. These are the same nondiscriminatory classification tests used for qualified plans ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3842">3842</a>).<a href="#_ftn4" name="_ftnref4">4</a> If a cafeteria plan offers health benefits, the plan is not discriminatory as to contributions and benefits if (1) contributions for each participant include an amount that either (x) equals 100 percent of the cost of the health benefit coverage under the plan of the majority of the highly compensated participants who are similarly situated (e.g., same family size); or (y) equals or exceeds 75 percent of the cost of the most expensive health benefit coverage elected by any similarly-situated participant; and (2) contributions or benefits in excess of (1) above bear a uniform relationship to compensation.<a href="#_ftn5" name="_ftnref5">5</a> A plan is considered to satisfy all nondiscrimination tests if it is maintained under a collective bargaining agreement between employee representatives and one or more employers.<a href="#_ftn6" name="_ftnref6">6</a> In addition, a “key employee,” as defined for purposes of the top-heavy rules ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3931">3931</a>), will be considered in constructive receipt of the available cash benefit option in any plan year in which nontaxable benefits provided under the plan to key employees exceed 25 percent of the aggregate of such benefits provided to all employees under the plan. For this purpose, excess group term life insurance coverage that is includable in income is not considered a nontaxable benefit.<a href="#_ftn7" name="_ftnref7">7</a> Employees of a controlled group of corporations, employers under common control, or members of an “affiliated service group” ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3935">3935</a>) are treated as employed by a single employer.<a href="#_ftn8" name="_ftnref8">8</a> Amounts that the employer contributes to a cafeteria plan pursuant to a salary reduction agreement will be treated as employer contributions to the extent that the agreement relates to compensation that has not been actually or constructively received by the employee as of the date of the agreement and subsequently does not become currently available to the employee.<a href="#_ftn9" name="_ftnref9">9</a> <hr align="left" size="1" width="33%"><a href="#_ftnref1" name="_ftn1">1</a>. IRC § 125(b) (1); Prop. Treas. Reg. § 1.125-7(m) (2). <a href="#_ftnref2" name="_ftn2">2</a>. IRC § 125 (e); Prop. Treas. Reg. § 1.125-7(a)(3); IR014-99 (Oct. 23, 2014), IR015-118 (Oct. 21, 2015), Notice 2016-62, Notice 2017-64, Notice 2018-83, Notice 2019-59, Notice 2020-79, Notice 2021-61, Notice 2022-55, Notice 2023-75. <a href="#_ftnref3" name="_ftn3">3</a>. IRC § 125 (g) (3); Prop. Treas. Reg. §1.125-7. <a href="#_ftnref4" name="_ftn4">4</a>. Prop. Treas. Reg. §1.125-7(b) (1). <a href="#_ftnref5" name="_ftn5">5</a>. IRC § 125 (g) (2); Prop. Treas. Reg. §1.125-7(e). <a href="#_ftnref6" name="_ftn6">6</a>. IRC § 125 (g) (1). <a href="#_ftnref7" name="_ftn7">7</a>. IRC § 125 (b) (2). <a href="#_ftnref8" name="_ftn8">8</a>. IRC § 125 (g) (4). <a href="#_ftnref9" name="_ftn9">9</a>. Prop. Treas. Reg. §1.125-1(r).

March 13, 2024

3506 / When can benefit elections under a cafeteria plan be changed?

Editor’s Note: The IRS has released Notice 2022-41 to change the rules governing mid-year election changes and cafeteria plans in light of the final regulations that fix the so-called "family glitch" under the ACA. Clients may wish to reevaluate their elections so that newly eligible family members may take advantage of premium tax credit. The client may choose to revoke the employee’s family coverage election to allow the employee and any family members may enroll in Marketplace coverage instead. In the alternative, the client may choose to revoke the employee’s family coverage election so the employee’s family members may enroll in Marketplace coverage (in this case, the employee would remain covered under the employer-sponsored plan). Typically, the employee is not permitted to change the family coverage election mid-year. Beginning January 1, 2023, however, a non-calendar year cafeteria plan may allow an employee to revoke an election for family coverage so that family members can enroll in ACA marketplace coverage if both of the following are true: (1) one or more of the employee’s family members are eligible to enroll in marketplace coverage during a special enrollment period or during Marketplace annual open enrollment, and (2) revoking the employee’s family coverage election corresponds with the intended enrollment of the family member in a marketplace plan. The IRS provided relief to permit certain mid-year election changes in the wake of the COVID-19 pandemic. For mid-year elections made during calendar year 2020 or 2021, a Section 125 cafeteria plan could permit employees who are eligible to make salary reduction contributions under the plan to: (1) with respect to employer-sponsored health coverage, (a) make a new election on a prospective basis, if the employee initially declined to elect employer-sponsored health coverage; (b) revoke an existing election and make a new election to enroll in different health coverage sponsored by the same employer on a prospective basis; and (c) revoke an existing election on a prospective basis, provided that the employee confirms in writing that the employee is enrolled, or immediately will enroll, in other health coverage not sponsored by the employer;and(2) revoke an election, make a new election, or decrease or increase an existing election applicable to a health FSA or dependent care assistance program on a prospective basis. If an employee has unused amounts remaining in a health FSA or a dependent care assistance program under the cafeteria plan at the end of a grace period or plan year ending in 2020 or 2021, the cafeteria plan may permit employees to apply those unused amounts to pay or reimburse medical care expenses or dependent care expenses incurred through 2021 or 2022, as applicable.<a href="#_ftn1" name="_ftnref1">1</a> This relief is optional for employers.<a href="#_ftn2" name="_ftnref2">2</a> Typically, there are only certain instances when a cafeteria plan may permit an employee to revoke an election during a period of coverage and to make a new election relating to a qualified benefits plan.<a href="#_ftn3" name="_ftnref3">3</a> A cafeteria plan may permit an employee to revoke an election for coverage under a group health plan during a period of coverage and make a new election that corresponds with the special enrollment rights of IRC Section9801(f). (This section deals generally with special enrollment periods for persons losing other group health plan coverage and dependent beneficiaries.)<a href="#_ftn4" name="_ftnref4">4</a> An election change with respect to the Section9801(f) enrollment rights can be funded through salary reduction under a cafeteria plan only on a prospective basis, except for the retroactive enrollment right under Section9801(f) that applies in the case of elections made within 30 days of a birth, adoption, or placement for adoption.<a href="#_ftn5" name="_ftnref5">5</a> Certain changes are permitted with respect to a judgment, decree, or order resulting from a divorce, legal separation, annulment, or change in legal custody (including a qualified medical child support order) that requires accident or health coverage for an employee’s child or for a foster child who is a dependent of the employee. A cafeteria plan may change the employee’s election to provide coverage for the child if an order requires coverage for the child under the employer’s plan. Also, the plan may permit the employee to make an election change to cancel coverage for the child if an order requires the spouse, former spouse, or other individual to provide coverage for the child and that coverage actually is provided.<a href="#_ftn6" name="_ftnref6">6</a> Additionally, if an employee, spouse, or dependent who is enrolled in the employer’s accident or health plan becomes entitled to coverage (i.e., becomes enrolled) under Medicaid or Part A or Part B of Medicare, the plan may permit the employee to make a prospective election change to reduce or cancel coverage of that employee, spouse, or dependent under the accident or health plan. Note that this does not apply to coverage consisting solely of benefits under the Social Security Act Section1928 program for distribution of pediatric vaccines. If an employee, spouse, or dependent that has been entitled to Medicaid or Medicare Part A or Part B coverage loses eligibility for the coverage, the plan may allow the employee to make a prospective election to commence or increase coverage of that employee, spouse, or dependent under the accident or health plan.<a href="#_ftn7" name="_ftnref7">7</a> An employee taking a leave under the Family and Medical Leave Act (FMLA) may revoke an existing election of accident or health plan coverage and make such election as provided for under the FMLA for the remaining portion of the period of coverage ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3509">3509</a>).<a href="#_ftn8" name="_ftnref8">8</a> Regarding contributions under a qualified cash or deferred arrangement, the regulations state that these provisions do not apply to elective contributions under such an arrangement, within the meaning of IRC Section401(k), or employee contributions subject to IRC Section401(m). Therefore, a cafeteria plan may allow an employee to modify or revoke elections as provided by these sections and applicable regulations.<a href="#_ftn9" name="_ftnref9">9</a> If a cafeteria plan offers salary reduction contributions to health savings accounts (HSAs), the plan must allow participants to prospectively change or revoke salary reduction elections for HSA contributions on a monthly, or more frequent, basis.<a href="#_ftn10" name="_ftnref10">10</a> <hr align="left" size="1" width="33%"><a href="#_ftnref1" name="_ftn1">1</a>. Notice 20209. <a href="#_ftnref2" name="_ftn2">2</a>. Notice 2021-15. <a href="#_ftnref3" name="_ftn3">3</a>. Treas. Reg. § 1.125-4(a). <a href="#_ftnref4" name="_ftn4">4</a>. Treas. Reg. § 1.125-4(b). <a href="#_ftnref5" name="_ftn5">5</a>. Treas. Reg. § 1.125-4(b)(2). <a href="#_ftnref6" name="_ftn6">6</a>. Treas. Reg. § 1.125-4(d). <a href="#_ftnref7" name="_ftn7">7</a>. Treas. Reg. § 1.125-4(e). <a href="#_ftnref8" name="_ftn8">8</a>. Treas. Reg. § 1.125-4(g). <a href="#_ftnref9" name="_ftn9">9</a>. Treas. Reg. § 1.125-4(h). <a href="#_ftnref10" name="_ftn10">10</a>. Prop. Treas. Reg. § 1.125(c).

March 13, 2024

3508 / Can an employee change benefit elections under a cafeteria plan because of significant cost or coverage changes?

The rules regarding election changes due to a significant cost or coverage changes apply to all types of qualified benefits offered under a cafeteria plan, but not to health flexible spending arrangements (FSAs).<a href="#_ftn1" name="_ftnref1">1</a> A plan may automatically make a prospective change in an employee’s salary reduction amount if the cost of a qualified benefits plan increases or decreases during a period of coverage. If the cost of a benefit package option significantly increases during a period of coverage, the cafeteria plan may allow employees to either increase their salary reduction amounts or revoke their elections for this benefit and elect another benefit package option that offers similar coverage on a prospective basis. If the cost of a qualified benefits plan significantly decreases during the year, the cafeteria plan may allow all employees, even those who have previously not participated in the plan, to elect to participate in the plan for the option with such decrease in cost. A cost change applies in the case of dependent care assistance only if the cost change is imposed by a dependent care provider who is not a relative of the employee, as defined in IRC Section152.<a href="#_ftn2" name="_ftnref2">2</a> If an employee has a significant curtailment of coverage under a plan during a period of coverage that is a “loss of coverage,” the cafeteria plan may permit the employee to revoke his or her election under the plan and elect to receive, on a prospective basis, coverage under another option providing similar coverage. The employee may drop the coverage if no similar option is available. A “loss of coverage” means a complete loss of coverage under the benefit package option or other coverage option (e.g., the elimination of an option, an HMO ceasing to be available in the area, or losing all coverage under the option by reason of an overall lifetime or annual limitation).<a href="#_ftn3" name="_ftnref3">3</a> Other events constituting a loss of coverage include: (1) a substantial decrease in medical care providers (such as a major hospital ceasing to be a member of a preferred provider network or a substantial decrease in the physicians participating in a preferred provider network or an HMO),(2) a reduction in the benefits for a specific type of medical condition or treatment with respect to which the employee or the employee’s spouse or dependent is currently in a course of treatment, or(3) any other similar fundamental loss of coverage.<a href="#_ftn4" name="_ftnref4">4</a> If an employee has a significant curtailment of coverage under a plan during a period of coverage that is not a “loss of coverage” (e.g., a significant increase in the deductible, the co-pay, or the out-of-pocket expense), the cafeteria plan may permit the employee to revoke his or her election under the plan and elect to receive, on a prospective basis, coverage under another option providing similar coverage.<a href="#_ftn5" name="_ftnref5">5</a> If a plan adds a new benefit package option or improves an existing benefit package option or other coverage option during a period of coverage, the cafeteria plan may allow eligible employees (whether or not they have previously made an election under the cafeteria plan) to revoke their election and to make an election on a prospective basis for coverage under the new or improved option.<a href="#_ftn6" name="_ftnref6">6</a> A cafeteria plan may allow an employee to make a prospective election change that corresponds to a change made under another employer plan (including a plan of the same employer or of another employer) or to add coverage under a cafeteria plan for the employee, spouse, or dependent if the employee, spouse, or dependent loses coverage under any group health plan sponsored by a governmental or educational institution.<a href="#_ftn7" name="_ftnref7">7</a> <hr align="left" size="1" width="33%"><a href="#_ftnref1" name="_ftn1">1</a>. Treas. Reg. § 1.125-4(f)(1). <a href="#_ftnref2" name="_ftn2">2</a>. Treas. Reg. § 1.125-4(f)(2). <a href="#_ftnref3" name="_ftn3">3</a>. Treas. Reg. § 1.125-4(f)(3)(ii). <a href="#_ftnref4" name="_ftn4">4</a>. Treas. Reg. § 1.125-4(f)(3)(ii). <a href="#_ftnref5" name="_ftn5">5</a>. Treas. Reg. § 1.125-4(f)(3)(i). <a href="#_ftnref6" name="_ftn6">6</a>. Treas. Reg. § 1.125-4(f)(3)(iii). <a href="#_ftnref7" name="_ftn7">7</a>. See Treas. Reg. §§ 1.125-4(f)(4), 1.125-4(f)(5).

March 13, 2024

3517 / What is a dependent care flexible spending arrangement?

Editor’s Note: The American Rescue Plan Act (ARPA) allowed employers to increase contribution limits for dependent care assistance programs (DCAPs) or dependent care FSAs to $10,500 for 2021. The 2021 CAA also allowed participants to carry over unused DCAP benefits from 2020 or 2021 into the following plan year. Initially, there was some confusion over the tax consequences if a participant took advantage of both the increased contribution limit and carryover relief. Notice 20216 clarified the issue by providing that participants could take advantage of both (1) tax-free reimbursements of contributions made during the 2021 plan year up to the maximum $10,500 limit and (2) tax-free reimbursements of amounts carried over from the prior year. In other words, a participant with a $5,000 carryover amount from 2020 and a $10,500 contribution in 2021 could take tax-free distributions up to $15,500 in 2021 if that participant incurred enough qualifying expenses during the 2021 plan year. Substantially the same rules apply to dependent care FSAs as health FSAs, except that the maximum amount of reimbursement need not be available throughout the period of coverage. A plan may limit a participant’s reimbursement to amounts actually contributed to the plan and still available in the participant’s account.<a href="#_ftn1" name="_ftnref1">1</a> Contributions to a dependent care FSA may not exceed $5,000 during a taxable year.<a href="#_ftn2" name="_ftnref2">2</a> <hr>Planning Point: With so many employees working from home in 2020 and 2021, many employees began rethinking contributions to dependent care FSAs.The rules governing changes to dependent care FSA contributions are more flexible than health FSAs. Employees are permitted to make mid-year changes in pre-tax contributions if their circumstancesrelating to the need for dependent care changes.Employees can reduce their contributions if they are working from home and do not need childcare, or they can increase the contributions when they return to work and need to provide for increased childcare costs. Further, employees who were furloughed or laid off might have asked whether their plan contains a spend-down feature. These features are optional but allow former employees to seek reimbursement for dependent care expenses incurred through the end of the tax year (even if their employment was terminated).Employers have the option of adding a spend-down feature at any time. <hr> Like a health FSA, a dependent care FSA may permit a grace period of no more than 2½ months following the end of the plan year for participants to incur and submit expenses for reimbursement.<a href="#_ftn3" name="_ftnref3">3</a> The $500 carryover rule applicable for health FSAs after 2013, however, is not available for participants in a dependent care FSA. The IRS has also approved the use of employer-issued debit and credit cards to reimburse for recurring dependent care expenses. Because expenses may not be reimbursed until the dependent care services are provided, reimbursements through debit cards must flow in arrears of expenses incurred.<a href="#_ftn4" name="_ftnref4">4</a> <hr align="left" size="1" width="33%"><a href="#_ftnref1" name="_ftn1">1</a>. Prop. Treas. Reg. § 1.125-5. <a href="#_ftnref2" name="_ftn2">2</a>. IRC § 129(a)(2)(A). This limit is not currently adjusted for inflation. <a href="#_ftnref3" name="_ftn3">3</a>. Notice 2005-42, 2005-1 CB 1204. <a href="#_ftnref4" name="_ftn4">4</a>. Notice 2006-69, 2006 CB 107.

March 13, 2024

3501 / What is a cafeteria plan?

A cafeteria plan (or “flexible benefit plan”) is a written plan in which all participants are employees who may choose among two or more benefits consisting of cash and “qualified benefits.” With certain limited exceptions, a cafeteria plan cannot provide for deferred compensation. See Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3502">3502</a>.<a href="#_ftn1" name="_ftnref1">1</a> Some cafeteria plans provide for salary reduction contributions by the employee and others provide benefits in addition to salary. In either case, the effect is to permit participants to purchase certain benefits with pre-tax dollars. A plan may provide for automatic enrollment whereby an employee’s salary is reduced to pay for “qualified benefits” unless the employee affirmatively elects cash.<a href="#_ftn2" name="_ftnref2">2</a> Under the 2007 proposed regulations (effective for plan years beginning on or after January1, 2009), the written plan document must contain the following: (1) a specific description of the benefits, including periods of coverage; (2) the rules regarding eligibility for participation; (3) the procedures governing elections; (4) the manner in which employer contributions are to be made, such as by salary reduction or nonelective employer contributions; (5) the plan year; (6) the maximum amount of employer contributions available to any employee stated as (a) a maximum dollar amount or maximum percentage of compensation or (b) the method for determining the maximum amount or percentage; (7) a description of whether the plan offers paid time off, and the required ordering rules for use of nonelective and elective paid time off; (8) the plan’s provisions related to any flexible spending arrangements (FSAs) included in the plan; (9) the plan’s provisions related to any grace period offered under the plan; and (10) the rules governing distributions from a health FSA to employee health savings accounts (HSAs), if the plan permits such distributions.<a href="#_ftn3" name="_ftnref3">3</a> The plan document need not be self-contained, but may incorporate by reference separate written plans.<a href="#_ftn4" name="_ftnref4">4</a> Note that under the ACA<a href="#_ftn5" name="_ftnref5">5</a>, the cost of an over-the-counter medicine or drug could not be reimbursed from FSAs or health reimbursement arrangements (HRAs) unless a prescription is obtained prior to 2020 (the CAREs Act permanently eliminated the prescription rule). The ACA rule did not affect insulin or other health care expenses such as medical devices, eyeglasses, contact lenses, co-pays and deductibles. The IRS advises employers and employees to take these changes into account as they make health benefit decisions.<a href="#_ftn6" name="_ftnref6">6</a> FSA and HRA participants may continue using debit cards to buy prescribed over-the-counter medicines, if requirements are met.<a href="#_ftn7" name="_ftnref7">7</a> In addition, starting in 2013, there were new rules about the amount that can be contributed to an FSA. For instance, a cafeteria plan may not allow an employee to request salary reduction contributions for a health FSA in excess of $3,200 for 2024 (the amount was $3,050 in 2023). A cafeteria plan offering a health FSA must be amended to specify the contribution limit (or any lower limit set by the employer). While cafeteria plans generally must be amended on a prospective basis, an amendment that was adopted on or before December 31, 2014, could be made effective retroactively, if in operation the cafeteria plan met the limit for plan years beginning after December 31, 2012. A cafeteria plan that does not limit health FSA contributions to the annual limit is not a cafeteria plan and all benefits offered under the plan are includible in the employee’s gross income. IRS Notice 2012-40 provided information about these rules (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3503">3503</a>) and flexibility for employers applying the new rules. On June28, 2012, the Supreme Court, in National Federation of Independent Business v. Sebelius,<a href="#_ftn8" name="_ftnref8">8</a> upheld the constitutionality of the Affordable Care Act, with only minor changes to certain Medicaid provisions. While most attempts to repeal or seriously modify the ACA have failed in Congress so implementation of the ACA and its requirements continues for the time-being, the individual mandate was repealed for tax years beginning after 2018.<a href="#_ftn9" name="_ftnref9">9</a> Former employees may be participants (although the plan may not be established predominantly for their benefit), but self-employed individuals may not.<a href="#_ftn10" name="_ftnref10">10</a> A full-time life insurance salesperson who is treated as an employee for Social Security purposes will also be considered an employee for cafeteria plan purposes.<a href="#_ftn11" name="_ftnref11">11</a> <hr align="left" size="1" width="33%"><a href="#_ftnref1" name="_ftn1">1</a>. IRC § 125(d). <a href="#_ftnref2" name="_ftn2">2</a>. Rev. Rul. 20027, 2002-1 CB 925. <a href="#_ftnref3" name="_ftn3">3</a>. Prop. Treas. Reg. § 1.125-1(c). <a href="#_ftnref4" name="_ftn4">4</a>. Prop. Treas. Reg. § 1.125-1(c)(4). <a href="#_ftnref5" name="_ftn5">5</a>. P.L. 111-148. <a href="#_ftnref6" name="_ftn6">6</a>. See IRS News Release IR010-95 (Sept.3, 2010). <a href="#_ftnref7" name="_ftn7">7</a>. IRS News Release IR010-128 (Dec.23, 2010). <a href="#_ftnref8" name="_ftn8">8</a> 567 U.S. 519 (2012). <a href="#_ftnref9" name="_ftn9">9</a>. See e.g., Miller, “The ACA Remains, but Targeted reforms Will be Sought’” SHRM, Jul.24, 2017 at www.shrm.org. <a href="#_ftnref10" name="_ftn10">10</a>. Prop. Treas. Reg. § 1.125-1(g). <a href="#_ftnref11" name="_ftn11">11</a>. IRC § 7701(a)(20); Prop. Treas. Reg. § 1.125-1(g)(1)(iii).