IRS Proposes New Regulations for Cafeteria Plans September 2007
On August 6, 2007, the IRS released new Section 125 proposed regulations to clarify and update cafeteria plan rules that have been in place for the last 23 years. The New Proposed Regulations replace previous “dash one” (1984) and “dash two” (1989) regulations. The New Proposed Regulations confirm what we already know, clarify rules and add new regulations. Below is a summary of the regulations as they are now published. The IRS has requested comments by November 5, 2007 in preparation for a hearing scheduled November 15, 2007. Final regulations will be released once the input has been reviewed. The effective date is for plan years beginning on or after January 1, 2009. However, the regulations may also be depended upon now. The New Proposed Regulations contains five sections: 1.125-1 General Operating Rules; 1.125-2 Participant Election Rules; 1.125-5 Flexible Spending Arrangement Rules; 1.1256 Substantiation Rules; and 1.125-7 Nondiscrimination Rules. It’s important to note that the IRS previously released finalized regulations 1.125-3 (FMLA Leave) and 1.125-6 (MidYear Election Changes). The New Proposed Regulations do not address these sections. Section 1.125-1 General Operating Rules This section clarifies that Code Section 125 is the exclusive means by which an employer can offer employees a choice between taxable and nontaxable benefits. Providing a choice outside the cafeteria plan results in the inclusion of the benefit in gross income. 1.125-1 confirms the cafeteria plan must be in writing and must include eligibility rules, election procedures, use-or-lose rules, how employer contributions will be made and the maximum amount of elective contributions, among others. Failure to follow the written terms of the cafeteria plan will disqualify the entire cafeteria plan. Plan amendments are only permitted to be effective for periods after the later of the adoption date or the effective date of the amendment. If an amendment adds a new benefit, only expenses incurred after the later of the effective date or the adoption of the amendment are eligible for reimbursement under the cafeteria plan. The plan must be for employees (common law, leased, full-time insurance salespeople). An employee’s spouse, domestic partner or dependents may receive benefits, though they may not be considered “participants” in the plan. Former employees (including laid off and retired) may participate, though the plan cannot be for the exclusive use of former employees. Qualified benefits include: group term life insurance on the life of the employee up to $50,000 (Section 79); employer provided accident and health plans; health flexible spending accounts; accidental death and dismemberment policies; shortterm and long-term disability policies; dependent care assistance program, adoption assistance program, contributions to a 401(k) plan, and contributions to a Health Savings Account.
IRS Proposes New Regulations for Cafeteria Plans September 2007
Nonqualified benefits include: scholarships; employer provided meals and lodging; educational assistance; fringe benefits including transportation plans; longterm care insurance; Archer Medical Savings Accounts; group term life for an employee’s spouse, child or dependent and elective deferrals to a 403(b) plan. Compensation used to pay benefits pre-tax can include severance pay and paid time off. Retirement plan distributions cannot be used for pre-tax salary reductions under a cafeteria plan. Employers are now to use the Table I cost exclusively to determine imputed income for pre-tax premiums paid for group-term life insurance coverage that exceeds $50,000. A cafeteria plan may pay or reimburse (though not from a flexible spending account) substantiated individual accident and health insurance premiums and COBRA premiums for an employee. If reimbursed directly by the employer, the premium must be paid prior to reimbursement. Non-qualified benefits may not be offered through a cafeteria plan even if paid with after-tax employee contributions. Treasury officials have informally indicated that including dependent life in the cafeteria plan document, while specifically stating that it is not part of the cafeteria plan itself should be sufficient to satisfy this rule. The New Proposed Regulations clarify that a two year election lock for dental and vision benefits is permissible. Section 1.125-2 Participant Election Rules The Plan must allow employees to elect nontaxable qualified benefits on an annual basis (except in the case of the permitted two year election lock for dental and vision benefits). The plan must allow employees to prospectively elect, revoke or change their salary reduction amounts for HSA contributions at least monthly. The New Proposed Regulations allow automatic election rules for new and current employees. The New Proposed Regulations allow new employees 30 days after their date of hire to make elections for coverage that may be effective retroactive to their date of hire. However, all salary reductions for this coverage must come from salary that is not yet currently available or paid. This is one area that may be updated when the final regulations are released. 1.125-5 Flexible Spending Arrangements The New Proposed Regulations confirmed the “Use-It-or-Lose-It-Rule” is here to stay. The rule has been renamed “Use or Lose.”
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IRS Proposes New Regulations for Cafeteria Plans September 2007
The New Proposed Regulations allows an FSA to be 100% funded by employer flex credits. The New Proposed Regulations state the maximum amount of FSA reimbursement must be less than 500% of salary reduction and employer flex credits. A reasonable minimum claim threshold can be applied (e.g. $50) for claims paid; however, claims must be reimbursed at least monthly. The uniform coverage rules apply to health FSAs (participant is able to receive up to their annual election at any time in the plan year). This rule does not apply to dependent care or adoption assistance. FSAs are required to have a 12 month period of coverage (except for short plan years). The period of coverage may differ from the plan year. Employers can also offer different periods of coverage for different qualified benefits. FSAs must only reimburse qualifying expenses incurred during the period of coverage. A health FSA can limit eligibility to employees who participate in one or more specified employer health plans. A health FSA may limit eligible expenses to only certain specified 213(d) expenses. For example, an FSA may exclude capital expenditures; over-the-counter drugs or be a limited purpose FSA (to be HSA compatible). A health FSA may reimburse orthodontia expenses when advance payment is required. This may not apply if prepayment is an option that would result in the participant receiving a discount. This is an area that will be reviewed again for the final regulations. A health FSA may reimburse 100% of the expense for durable medical equipment in the year incurred even if the useful life extends to subsequent years. The New Proposed Regulations restate the existing rules related to the interaction of health FSAs and HSAs. Contributions may be made on whatever schedule the employer selects, including the payroll schedule or in equal installments at regular intervals (for example, quarterly). These rules must apply uniformly to all participants. The New Proposed Regulations retain the forfeiture allocation rules and clarify that an employer may retain forfeitures, use forfeitures to pay for administrative expenses or allocate the forfeitures among participating employees. The grace period extension was included as a plan design option. The grace period amendment extends the period in which employees may incur expenses and receive reimbursement from the prior year FSA balance. The 2 month 15 day maximum remains in effect.
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IRS Proposes New Regulations for Cafeteria Plans September 2007
Optional rules allow an employer to reimburse employee’s qualified dependent care expenses incurred after termination through a dependent care FSA. 1.125-6 Substantiation Rules The New Proposed Regulations confirm that all claims must be substantiated and that substantiation must occur before the claim can be reimbursed or paid. Advance reimbursement is not permitted. Nor is substantiating only a sample of FSA claims or substantiating only claims over a certain dollar amount. The New Proposed Regulations incorporate previous guidance regarding the use of debit and credit cards. The new regulations appear to allow cards to be used by former employees who continue to participate in the FSA. Auto reimbursement for debit cards is allowed for copayment, matching the recurring expense and real-time substantiation, including IIAS Point of Sale substantiation. Auto approval is allowed for dependent care expenses when the claim has been substantiated and the employee and dependent care provider have signed off verifying the ongoing expense. If a new benefit is added mid plan year, only expenses incurred after the later of the effective date or the adoption date are eligible for reimbursement. Section 1.125-7 Nondiscrimination Rules This section focuses on key terms, the eligibility test and the contributions and benefits test. Highly compensated individuals or participants are defined consistent with Code Section 414(q) definition. The eligibility test incorporates a major portion of the rules under Code Section 410(b) and the related regulations. The New Proposed Regulations clarified the contributions and benefits test and added an objective test to determine when the actual election of benefits is discriminatory. The cafeteria plan must give each similarly situated participant a uniform opportunity to elect qualified benefits and highly compensated participants must not disproportionately elect qualified benefits in actual results. The New Proposed Regulations provide guidance on the Code Section 125 safe harbor for cafeteria plans that provide health benefits and create a new safe harbor for premium-only plans.
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IRS Proposes New Regulations for Cafeteria Plans September 2007
Finalized Dependent Care Regulations On August 14, 2007, the IRS issued final Dependent Care Regulations. The Final Regs are effective for taxable years beginning on or after August 14, 2007 (i.e. January 1, 2008). Preschool and Kindergarten: Expenses for nursery school, pre-school and similar programs below the kindergarten level are presumed to be for the care of a qualifying individual. Expenses associated with kindergarten or higher are not qualified dependent care. Speciality Day Camps: Speciality day camps that focus on a particular activity (soccer, computers) may be considered care for a qualifying individual and an eligible expense for reimbursement. However, summer school and tutoring programs are considered school and education and do not qualify as dependent care. Temporary Absence Rule: Expenses continue to qualify for reimbursement if a participant is required to pay for day care when absent from work on a temporary basis. This includes an absence due to short-term illness or vacation. An absence of no more than two consecutive weeks is considered a temporary absence. Cost of overnight care (not overnight camp) and day care may be viewed as an employment related expense for a qualifying individual when one spouse works during the day and the other works at night and sleeps during the day. Changes to the definition of “qualifying individual” and “custodial parent” were made to conform to changes made by the Gulf Opportunity Zone Act of 2006. Transportation: Cost of transportation provided by a day care provider to or from the place where the care is provided may be considered care for the qualifying individual. Application and Agency Fees: May be considered eligible expenses if and only if the employee is required to pay the fee to obtain the care and only if the care is actually provided or incurred.
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