This alert was updated on 04/29/20.
A cafeteria plan, or Section 125 plan, sometimes referred to as a POP plan, allows employees to pay for certain expenses on a pretax basis. Employees choose between a taxable benefit (cash, typically distributed via payroll) and two or more pre-tax qualified benefits. Just like standing in line at a cafeteria and selecting a salad, a plate of meatloaf, and a carton of milk, employees can “stand in line” and select health insurance, vision insurance, and dental insurance – and more! The IRS limits the benefits that can be offered through a cafeteria plan.
- Coverage under an accident or health plan (traditional health insurance, self-insured reimbursement plans, dental, vision, etc.)
- Health care expense reimbursement plans (FSAs)
- Dependent care assistance benefits
- Paid time off
- Adoption assistance benefits
- Health savings accounts (HSAs)
- Group term life
- 401(k) contributions
Employees can make elections and select which of the offered benefits they would like to enroll in. Employees can choose to cover other individuals, including spouses and dependents, if the employer’s plan allows. These elections are prospective, with an exception for new hires. The IRS considers pre-tax elections to be irrevocable unless a permitted event occurs. These events sometimes overlap and fall into 3 general categories, HIPAA Special Enrollment Events, Change in Status Events, and Other Triggering Events.
The only events that a plan sponsor must recognize are HIPAA special enrollment events, as long as the plan is subject to HIPAA. Almost all plans are subject to HIPAA. All of the other events are optional, and a plan sponsor must ensure their plan documents affirmatively indicate which of the vents are recognized.
|Gain dependent(s) due to marriage||Employee or dependent becomes entitled to Medicare or Medicaid||Employee/dependent status change results in gaining eligibility under the plan (e.g., new job; part-time to full-time)||Plan makes SIGNIFICANT cost change||Plan makes automatics small cost change(s)|
|Lose spouse (e.g., divorce, legal separation, death of spouse)||Employee or dependent becomes entitled to premium assistance subsidy for Medicaid or CHIP||Employee/dependent employment change results in losing eligibility under employer plan (e.g., full to part-time; unpaid leave)||Plan makes SIGNIFICANT curtailment in coverage||Other employer’s plan increases/decreases/ceases coverage|
|Gain/lose child (e.g., birth adoption or placement for adoption/death)||Employee or dependent loses entitlement for Medicare, Medicaid, or CHIP||Employee hours of reduced to average less than 30 hours a week||Plan eliminates/adds new benefit or coverage option||Other employer’s plan offers open enrollment|
|Dependent loses/gains eligibility (e.g., child reaches age limit/becomes student after age 26)||Change in residence triggers gain/loss eligibility (e.g., move in/out of a plan services area||Employee becomes eligible to enroll in a QHP in the Marketplace||Order requiring plan to add child(ren) to health plan coverage||Order requiring another employer’s plan to add child(ren) to health plan coverage|
The following situations are not cafeteria plan qualifying events:
- Change in employee’s finances
- Change in employee’s medical condition (worsens/heals)
- Health insurance carrier permitting special open enrollment (for example, during COVID-19 pandemic)
- Provider leaves network, unless it results in a significant reduction of coverage (e.g., only gastroenterologist in the network leaves)
- Legal separation, unless it causes the spouse to lose eligibility
- Commencement of domestic partner relationship
- Dependent or spouse leaves/returns from prison/jail, unless it causes the individual to lose HMO eligibility due to change in residence
The IRS may be less likely to penalize plan sponsors that allow a special open enrollment given the unprecedented circumstances; however, employers need to be aware that there is still risk and provide it on a uniform and reasonable basis. As there is potential risk, an employer should strongly consider having contributions be post-tax as it can help reduce risk of allowing employees enroll in a plan without having a
qualifying event. If employers choose to allow a special open enrollment due to COVID-19 concerns, they may want to update their plan documents to reflect this period.
|Employers who are considering allowing employees to come onto the plan due to a non-qualifying event (such as carrier’s open enrollment) should consider the following:|
Dependent care accounts (DCAPs) and flexible spending arrangements (FSAs) also create unique issues due to the cafeteria plan regulations.
DEPENDENT CARE ASSISTANCE PROGRAMS
DCAPs, sometimes referred to as “dependent flex spending accounts” are an employer-sponsored plan to provide the exclusive benefit of dependent care assistance. Under the Internal Revenue Code (IRC) employees can exclude up to $5,000 annually from the gross income for dependent care. DCAPs are subject to flexible spending arrangement rules under the IRC. These arrangements can cause issues when employees are no longer working and not in need of childcare, or alternatively, an employee’s childcare program/center/provider has closed due to the pandemic.
Because of their tax favored status, DCAPs are subject to many regulations. Any common law employee can participate in a DCAP. In order to have dependent care expenses reimbursed by the program the following general requirements must be met:
- The expense must enable the employee (and their spouse) to be gainfully employed
- The expense must be for a qualifying individual (a child under the age of 13)
- The expense must be for care, not education (daycare is acceptable, private school tuition is not)
- The expense must be incurred in the coverage period (the plan year)
- The expense must be substantiated
EXCLUSION FROM INCOME
An employee’s exclusion from income for payments under a DCAP in a calendar year is limited to the smallest of the following amounts:
- $5,000 if the employee is married and filing a joint return or if the employee is a single parent ($2,500 if the employee is married but filing separately);
- the employee’s “earned income” for the year; or
- if the employee is married at the end of the taxable year, the spouse’s earned income
The spouse of a married employee is deemed to be gainfully employed and to have an earned income of not less than $250 per month if there is one qualifying individual, or $500 per month if there are two or more qualifying individuals in each month during which they are a full-time student, or is incapable of self-care and has the same principal place of abode as the employee for more than half the year.
LEAVE OF ABSENCE
If an employee takes a leave of absence they may no longer be considered “gainfully employed” and eligible for dependent care reimbursements during their leave. In general, this is determined on a daily basis, however, there is an exception to the “daily basis” rule for certain short, temporary absences (e.g. Emergency Paid Sick Leave) and part-time employment.
This exception is based on the IRS regulations establishing a “safe harbor” under which an absence of up to two consecutive calendar weeks is treated as a short, temporary absence. However, whether an absence for longer than 2 weeks qualifies as short and temporary is determined on the basis of facts and circumstances.
Likewise, when it comes to FMLA, the IRS does not agree that one’s entire absence under FMLA (which guarantees eligible employees up to 12 weeks of unpaid leave for certain purposes) is appropriate as a temporary absence safe harbor, noting that an absence of 12 weeks “is not a short, temporary absence” within the meaning of the regulations.
Reimbursements are subject to the same rules as flexible spending arrangements (FSAs). The period of coverage must be 12 months unless there is a short plan year. DCAPs that are underspent lead to forfeited money, unused contributions cannot carry over from year to year. DCAPs are not subject to COBRA and the participant has no right to coverage after their plan participation terminates. Employers can provide for a spend- down provision in their plan documents to allow former employees to receive reimbursement through the end of the plan year in which they terminated employment and coverage. If the plan document does not provide for this spend down, the funds are forfeited.
REIMBURSEMENTS DURING LEAVE OF ABSENCE
Although the employee may not be eligible to reimburse dependent care expenses while on leave, an employee on LOA may be able to continue to participate in (and make contributions to) a DCAP but any reimbursements from the DCAP will still be subject to the gainfully employed rule and would have to fall within the exception for short, temporary absences.
CHANGES TO ELECTIONS
Under the cafeteria plan regulations, elections are irrevocable unless a permitted event occurs. For DCAPs this is:
- A change in status
- A change in cost and coverage
- FMLA (employees taking FMLA leave can revoke elections of non-health benefits and reinstate their benefits upon return from leave)
REMINDER: Although IRS rules govern dependent care assistance programs (DCAPs) also known as dependent care FSAs, including the requirement that elections are irrevocable except in the case of a “change event”, an employer is not required to recognize all the IRS permitted election changes when designing their FSA plan. Therefore, if an employee requests to change their dependent care FSA election, employers need to be mindful of:
- FSA plan document language – must explicitly permit changes to elections due to a change in cost. If it does not, an employer may want to consider prospectively amending their plan to include this change event.
- Following their plan’s rules to avoid plan disqualification
- Refunds for dependent care FSA contributions already taken from an employee’s paycheck are not permissible.
|Dependent Care Change in Status, or Cost & Coverage Events||DCAP Election Change|
|A new childcare provider is available at a different cost than current provider. Includes someone (e.g. parent, older sibling) agreeing/able to watch the child for free.||Employee may increase or decrease election amount consistent with change in qualified dependent care expenses.
Employee may cancel the election if child is now being cared for at no cost.
|Enrolling child at a childcare provider closer to home or new work location.||Employee may increase or decrease election amount consistent with change in cost.|
|An employee or their spouse has a new work schedule (including to or from part-time status), and a different number of hours of childcare are required.||Employee may increase or decrease election amount consistent with change in cost.|
|A child who wasn’t previously enrolled in childcare now needs a childcare provider due to schools being closed.||Employee may enroll in dependent care FSA. Or increase their election if they are enrolling an additional child not previously enrolled in childcare.|
|Child’s daycare closed||Employee may decrease or cancel their election.|
It is likely that many of the reasons an employee no longer needs childcare as the result of the COVID-19 pandemic would allow them to change their DCAP contributions, potentially reducing them to zero dollars, particularly if their child has been pulled from care (change in cost and coverage), or they are taking FMLA leave (including the newly created emergency FMLA leave under the new Families First Coronavirus Response Act).
Therefore, employers should be lenient and allow employees to change their DCAP contributions within the above scenarios. Employers with employees who are laid off (not expected to return to work) should consult with counsel to see if their plan documents allow for a spend down, or if that change can be made mid-plan year.
HEALTHCARE FLEXIBLE SPENDING ACCOUNT PROGRAMS (HCFSAS)
Similar to DCAPs, health FSA elections generally are irrevocable and the IRS only permits mid-year changes when an IRS approved qualifying status change has occurred. Any change in employment status of the employee, spouse or dependent that affects eligibility for the health FSA is a qualified status change and the change in the election must be on account of the qualified status change.
REMINDER: A health care FSA may (but is not required) to permit an employee to change their health FSA election for IRS permitted qualifying change in status events. Employers should refer to their FSA plan documents to determine which events their plan recognizes
Change in Status Events
Health FSA Election Change
|Spouse (or dependent) loses health insurance coverage||Employee may increase election amount|
|Employee changes from FT to PT||Employee may revoke election if the change affects eligibility for the health FSA (Note: Employee may lose coverage automatically when hours change to PT.) COBRA paperwork may need to be provided if the account is underspent. (The health FSA balance
is equal to or more than the amount of FSA premiums charged for the remainder of the plan year.)
|Employee is on layoff or furlough||If the employee stops getting paid, the FSA technically ends. COBRA should be offered to continue the FSA. The employer may keep the FSA active by providing contributions for the employee, having the employee send payments into the employer, or catching up the contributions upon return.|
|Employee is on an unpaid, unprotected leave of absence (e.g. not FMLA)||If eligibility is lost, employee may revoke election. COBRA paperwork may need to be provided if the account is underspent.|
|Employee is on FMLA or Emergency FMLA Extension under FFCRA||Employee may revoke election for the period of coverage provided for under FMLA or EFMLEA (or the employer may allow the employee to continue coverage but discontinue contributions during the leave period.)|
|Termination of employment – employee||Employee’s coverage ends. COBRA paperwork may need to be provided if the account is underspent.|
|Termination of employment for spouse, dependent who had health insurance or health FSA.||Employee may enroll or increase election|
|Termination and Rehire Within 30 Days||Employee’s elections in effect at termination are reinstated unless another event has occurred that allows a change.|
|Termination and Rehire After 30 Days||Depending on the FSA plan design, the employee may reinstate elections in effect at termination or make a new election under the plan. It is possible, though for the FSA plan to prohibit an employee from re-enrolling in the plan during that plan year.|
Section 125 Operational Failure Exposure
According to the regulations, a plan that fails to operate in accordance with its terms or otherwise fails to comply with the Code or regulations “is not a cafeteria plan,” and employees’ elections between taxable and nontaxable benefits result in gross income to employees.
Furthermore, the IRS could choose to treat the plan as if it did not exist. This would disqualify the plan and result in employer employment tax withholding liability and penalties for all employee pre-tax and elective employer contributions. Employees could also be required to pay employment and income taxes and penalties on their pre-tax and elective employer contributions.
Errors in violation of ERISA, COBRA, and HIPAA could also expose a sponsor to damages from private lawsuits as well as penalties.
• Cafeteria plan disqualification – the plan would no longer exist and neither the employer nor employee can enjoy tax-preferred status on their benefits
• Requiring the cafeteria plan to comply with Section 125 and its regulations, including reversing transactions that caused noncompliance. This could have tax filing implications to the employer and the employee(s)
• Imposing employment tax withholding liability and penalties on the employer regarding pre-tax salary reductions and elective employer contributions. This could have tax filing implications to the employer.
• Imposing employment and income tax liability and penalties on employees regarding pre-tax salary reductions and elective employer contributions. This could have tax filing implications to the employee.
The information contained herein should be understood to be general insurance brokerage information only and does not constitute advice for any particular situation or fact pattern and cannot be relied upon as such. Statements concerning financial, regulatory or legal matters are based on general observations as an insurance broker and may not be relied upon as financial, regulatory or legal advice. This document is owned by Alera Group, Inc., and its contents may not be reproduced, in whole or in part, without the written permission of Alera Group, Inc. Reviewed as of 4/29/2020.
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