Category Archives: Flex Plans

Untangling ACA Opt-Out Payment Rules

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As group health coverage premiums soar ever higher, it has become increasingly popular for employers to offer employees cash in exchange for their opting out of group coverage. When the cash opt-out payments are provided outside of a Section 125 cafeteria plan, they may have the unintended consequence of reducing the affordability of employer group health coverage, because the IRS views the cash opt-out payment as compensation that the employee effectively forfeits by enrolling in coverage.[1]  Unaffordable coverage may entitle the employee to premium tax credits under IRC § 36, and may also exempt the employee from individual mandate duties under IRC § 5000A.  This post focuses on the impact of opt-out payments on “applicable large employers” subject to employer shared responsibility duties under the ACA.  For such employers, reduced affordability of coverage will impact how offers of coverage are reported under ACA reporting rules (IRC § 6056) and could trigger excise tax payments under IRC § 4980H(b).

By way of background, the IRS addressed opt-out payments last year in the form of Notice 2015-87, concluding that a “conditional” opt-out payment – one that requires that the employee meet a criterion in addition to declining employer group coverage, such as showing proof of other group coverage – would not affect affordability. The Notice also offered transition relief for unconditional offers (paid simply for declining employer coverage) that were in place as of December 16, 2015, the date the Notice was published.  Unconditional opt-out arrangements adopted after December 16, 2015 do impact affordability.

Subsequently, in July 2016, the IRS addressed the affordability issue in proposed regulations under IRC § 36, governing individuals’ eligibility for premium tax credits. The proposed regulations refer to “eligible” opt-out arrangements rather than conditional ones.  An eligible opt-out payment  is one under which an employee’s right to receive payment is conditioned on the employee providing reasonable evidence that the employee and all his or her dependents (the employee’s “expected tax family”) have or will have minimum essential coverage other than individual coverage (whether purchased on or off the health exchange/Marketplace).  Reasonable evidence may include the employee’s attestation to the fact of other coverage, or provision of proof of coverage, but in any event the opt-out payment cannot be made if employer knows or has reason to know that the employee/dependents does not have or will not have alternative coverage.  Evidence of the alternative coverage must be provided no less frequently than every plan year, and no earlier than the open enrollment period for the plan year involved.

The proposed regulations are expected to be finalized this year and thus the “eligible opt-out arrangement” rules likely will apply to plan years beginning on or after January 1, 2017.   In the meantime, the following provides guidance to applicable large employers on conditional and unconditional opt-out payments for purposes of 2016 ACA compliance, and ACA reporting due to be furnished to employees and filed with the IRS early in 2017:

Unconditional opt-out arrangement: opt-out payments increase employee contributions for purposes of the “affordability” safe harbor, and should be added to line 15 of Form 1095-C, unless the arrangement was already in effect on December 16, 2015.  “In effect” for these purposes means that (i) the employer offered the arrangement (or a substantially similar arrangement) for a plan year that includes December 16, 2015; (ii) the employer’s board of directors or authorized officer specifically adopted the arrangement before December 16, 2015; or (iii) the employer communicated to employees in writing, on or before December 16, 2015, that it would offer the arrangement to employees at some time in the future.

Conditional opt-out arrangement: opt-out payments do not increase employee contributions whether or not the condition is met.  Do not include the opt-out payment in line 15 of Form 1095-C.

Opt-out arrangement under a collective bargaining agreement (CBA): if the CBA was in effect before December 16, 2015, treat as a conditional opt-out arrangement, as above, and do not include in line 15 of Form 1095-C.

Medicare Secondary Payer Act/TRICARE Implications: An applicable large employer for ACA purposes will also be subject to provisions of the Medicare Secondary Payer Act (MSPA) that prohibit offering financial incentives to Medicare-eligible employees (and persons married to Medicare-eligible employees) in exchange for dropping or declining private group health coverage[2]. In the official Medicare Secondary Payer (MSP) Manual, the Centers for Medicare and Medicaid Services (CMS) takes the position that a financial incentive is prohibited even if it is offered to all individuals who are eligible for coverage under a private group health plan, not just those who are Medicare-eligible. Traditionally the CMS has not actively enforced this rule, and has focused on incentives directed at Medicare-eligible populations. However, there are reports that the CMS may be retreating from its unofficial non-enforcement position with respect to opt-out payments. At stake is a potential civil monetary penalty of up to $5,000 for each violation. As a consequence, MSPA-covered employers with Medicare-eligible employees, or employees who are married to Medicare-eligible persons, should not put an opt-out arrangement in place, or continue an existing one, without first checking with their benefits attorney. Finally, please note that there are similar prohibitions on financial incentives to drop military coverage under TRICARE. TRICARE is administered by the Department of Defense, but along the same principles as apply to MSPA.

Note:   This post was published on October 6, 2016 by Employee Benefit Adviser.

[1] Note: employer flex contributions to a cafeteria plan reduce affordability unless they are “health flex contributions,” meaning that (i) the employee cannot elect to receive the contribution in cash; and (ii) the employee may use the amount only to pay for health-related expenses, whether premiums for minimum essential coverage or for medical expense reimbursements permitted under Code § 213, and not for dependent care expenses or other non-health cafeteria plan options. See IRS Notice 2015-87, Q&A 8.

 

[2] An employer is covered by the MSPA if it employs 20 or more employees for each working day in at least 20 weeks in either the current or the preceding calendar year.

 

 

 

 

 

 

 

 

 

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Filed under Affordable Care Act, Applicable Large Employer Reporting, Benefit Plan Design, Cafeteria Plans, Employer Shared Responsibility, Flex Plans, Health Care Reform, PPACA

Final Rules on Wellness Program Design: A Chart and FAQs

Recent months have seen a flurry of new guidance related to wellness programs:

  • On May 17, 2016 the EEOC published final regulations and interpretive guidance on wellness programs that include disability-related questions (such as a Health Risk Assessment or HRA) and/or medical examinations (such as biometric testing). The new rules and guidance fall under Title I of the Americans with Disabilities Act (ADA), which permits collection of medical information under an employer’s “voluntary” wellness program. They replace proposed rules and guidance which were published in April 2015. We addressed the proposed rules in an earlier post.
  • In addition, EEOC published in the same issue of the Federal Register final regulations on wellness program participation by employees’ spouses, under Title II of the Genetic Information Nondisclosure Act (GINA). For GINA purposes, health status or health history about a family member, including a spouse, constitutes genetic of the employee. The rule replaces proposed regulations issued in October 2015.
  • In connection with the final rules the EEOC also published a model confidentiality notice to be provided to wellness program participants.
  • Finally, the Internal Revenue Service issued guidance regarding taxation of cash rewards to participate in wellness programs, and reimbursement of premiums paid through cafeteria plan deductions.

Overview. The new ADA and GINA regulations supplement, and in some instances contradict, existing wellness regulations under HIPAA, as modified by the ACA. Most notably, the HIPAA/ACA rules do not impose any incentive limitation on wellness programs that are “participation only,” whereas the ADA and GINA rules do impose a maximum incentive limit if the “participation only” program includes an HRA or biometric testing. The ADA and GINA regulations apply to employers with 15 or more employees, and to wellness programs that are “self-standing” as well as those offered in connection with a group health plan. HIPAA/ACA rules apply only to wellness programs that themselves comprise a group health plan, or that are offered with group health plans.

Effective Dates. The ADA and GINA incentive limits and ADA notice requirement discussed below go into effect for plan years beginning on or after January 1, 2017 (in most cases this will be the year of the health plan to which the wellness program relates). Employers may choose to voluntarily comply with these rules prior to that time. The balance of the new guidance goes into effect immediately, as the EEOC has characterized it as clarification of existing law.

Compliance Chart. Below is a chart summarizing permissible dollar or in-kind incentives for wellness program participation, along with some other requirements under the new ADA and GINA regulations, followed by some frequently asked questions on the new wellness program guidance.

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* If multiple health plans are offered, the 30% limit applies to the lowest cost major medical plan. If no plans are offered, the reference point is the premium paid for a 40 year old non-smoker enrolled in the second-lowest silver plan on the health exchange in the employer’s region.

Q.1:     What are reasonable design criteria for wellness programs under ADA regulations? 

A.1:      A wellness program is “reasonably designed to promote health or prevent disease” if it is (a) not highly suspect in the method chosen to promote health or prevent disease; (b) does not require an overly burdensome period of time to participate, involve unreasonably intrusive procedures or significant costs; (c) is not a subterfuge for violating the ADA or other legal requirements or a means to simply shift costs from employer to employees; and, (d) if medical information is collected, the program provides feedback or advice to participants about risk factors or uses aggregate medical data to design programs or treat specific conditions.

Q.2: How do these requirements differ from the requirements for wellness programs under HIPAA/ACA?

A.2: In addition to the differences in incentive limits noted in the chart above, the HIPAA/ACA test applies a reasonable design criteria only to health-contingent wellness programs, while the ADA rules apply to participation-only wellness programs that include HRAs and/or biometric testing.  In addition, the HIPAA/ACA rules require that participants have a chance to qualify for the full incentive at least annually, and must offer to waive incentive criteria, or offer a reasonable alternative standard, to permit equal participation by all similarly situated participants.  This is somewhat similar, but not identical, to the ADA reasonable accommodation requirement.  HIPAA/ACA also requires that notice of the waiver/reasonable alternative standard be provided.

Q.3: Do GINA wellness program regulations add any requirements?

A.3: Yes, if a spouse is requested to complete an HRA or undergo biometric testing, a separate incentive limit equal to 30% of the total cost of self-only coverage applies, and the spouse must sign a written, knowing and voluntary authorization to take part in the HRA or biometric testing.  The authorization must describe the genetic information being obtained (e.g. health history information in an HRA), how it will be used, and any restrictions on its disclosure.  Additionally, employers may not deny access to coverage or otherwise retaliate in the event a spouse refuses to provide HRA/biometric testing.

Q.4: What are the criteria of a “voluntary” wellness program under ADA regulations?

A.4: A wellness program is voluntary for ADA purposes if employees are not required to participate in the program, are not punished for not participating (e.g., not granted access to all health benefits or plan options), and are not subjected to adverse employment action, retaliation, coercion or other prohibited conduct in order to get them to participate, or to reach certain health goals. In addition, incentives are capped at the percentages shown in the chart, and participants are provided with a written notice re: collection and use of medical information.  The EEOC has provided a form of model notice.

Q.5: What does the model EEOC notice state, and is it mandatory or can we use our own version?

A.5: The notice, which should be provided prior to participation in an HRA or biometric exam, may be modified but must be written in language that recipients can understand, and must describe what medical information is collected, what measures will be used to protect its privacy and security, and must state that the information will not be sold, exchanged, transferred, or otherwise disclosed except as necessary and permitted under law in order to implement the wellness program.  Some of the provisions may repeat provisions of an existing HIPAA privacy notice.

Q.6: Can we email the ADA wellness program notice or must we distribute by hand?

A.6: You can email it so long as you are certain the email will reach the intended employees, e.g. through use of a current work email address, and so long as proper attention is brought to the nature of the notice (for instance, do not attach it to an email already containing a number of other, unrelated human resource forms or disclosures). You may also distribute in hard copy.  Your distribution method should take into account employee disabilities such as visual impairment, or learning disabilities.

Q.6: What confidentiality requirements apply under ADA regulations?

A.6: The employer must receive wellness data in aggregate form only, and may not require an employee to agree to the sale, exchange, sharing, transfer or other disclosure of medical information, or to waive ADA confidentiality protections, as a condition for participation.  Note that ADA confidentiality rules would apply to a wellness program not linked to a group health plan, and for a wellness program that is a health plan or is linked to one, HIPAA/ACA privacy, security and breach notification measures must also be followed.  These rules independently would prohibit the employer from viewing individualized health data.

Q.7: What is the impact of “de minimis” wellness incentives such as tee-shirts and water bottles?

A.7: The ADA regulations do not recognize a “de minimis” rule, thus the approximate dollar value of all “in-kind” incentives should be counted towards the 30% incentive limit.  By contrast, for federal income tax purposes, the IRS allows small items such as tee-shirts and water bottles to be excluded from participants’ taxable income as de minimis fringe benefits under Internal Revenue Code (“Code”) Section 132(e).  See IRS Memo 2016-22031, discussed below.

Q.8: How does the IRS treat cash incentives to participate in a wellness program treated under the Internal Revenue Code?

A.8: In IRS Memo 2016-22031 the IRS concluded that cash incentives to take part in a wellness program, or amounts paid or reimbursed for more than de minimis items that do not qualify as Code Section 213(d) medical expenses (such as gym memberships) are included in employees’ taxable income.  The same is true when an employer uses a wellness program to reimburse employees for premium or other coverage amounts withheld from their salary under a Section 125 cafeteria plan.

Q.9: What is the ADA’s  “insurance safe harbor” or “bona fide benefit plan” safe harbor, and can employers use it to justify a wellness program that does not meet the new ADA wellness program criteria?

A.9: The insurance safe harbor or “bona fide benefit plan” safe harbor permits the gathering of health data from employees so long as it is for underwriting or risk classification purposes, e.g., in order to determine insurability or establish premiums and other costs of coverage.   The safe harbor typically would apply to an insurance carrier but also could apply to a self-insured health plan.  In the past several years, a few employers have successfully used the safe harbor to prevail over EEOC federal court challenges to wellness programs that conditioned very high financial incentives on completion of an HRA or biometric testing; see, e.g., Seff v. Broward County, 691 F.3d 1221 (11th Cir. 2012); EEOC v. Flambeau, Inc., 131 F. Supp. 3d 849 (W.D.Wis. 2015).  The ADA regulations expressly make the insurance safe harbor unavailable to employers sponsoring wellness programs, but this does not resolve how the issue will be determined in federal courts.

Q.10: Are there other GINA regulations that impact wellness programs?

A.10: Yes, Title I of GINA applies to health insurance issuers and group health plans (including self-insured health plans), and prohibits requiring an individual to provide genetic information (including through answering a family history question on an HRA) prior to or in connection with plan enrollment, or at any time in connection with “underwriting purposes,” which broadly refers to any provision of a reward or incentive.  As a result of GINA Title I, a plan may use an HRA that requests family medical history only if it is requested to be completed after plan enrollment and is unrelated to enrollment, and if there is no premium reduction or any other reward offered.

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Filed under Affordable Care Act, Americans with Disabilities Act, Benefit Plan Design, Cafeteria Plans, Flex Plans, Fringe Benefits, GINA/Genetic Privacy, Health Care Reform, HIPAA and HITECH, PPACA, Wellness Programs

Summary Chart of Disallowed Pay or Play Tactics

With the January 1, 2015 employer shared responsibility deadline fast approaching, the three government agencies charged with ACA compliance (IRS, DOL and HHS) have provided recent guidance on several strategies or tactics that have been marketed to applicable large employers as legitimate ways to reduce their coverage costs and exposure to shared responsibility penalty taxes (assessable payments).   Employer reimbursement of individual health insurance premiums is a common but not universal feature of these arrangements.  The Internal Revenue Service ruled out pre-tax reimbursement of individual health premiums in Notice 2013-54, but more recent guidance in ACA FAQ XXII and in IRS Notice 2014-69 expands the prohibition to include after-tax individual premium reimbursements, as well as other shared responsibility cost reduction strategies.  The chart attached below summarizes:

  • the disallowed strategies;
  • the reasons why they were disallowed;
  • the penalties that may apply to applicable large employers that persist in pursuing these strategies; and
  • other relevant facts and concerns.

Disallowed Tactic Chart

As with all content provided on this blog, the chart is meant to serve as a general summary of legal developments and the information it contains should not be applied to any particular factual situation without first consulting experienced tax or benefits counsel.

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Filed under Affordable Care Act, Benefit Plan Design, Cafeteria Plans, Employer Shared Responsibility, ERISA, Flex Plans, Health Care Reform, HIPAA and HITECH, PPACA

Implementing the Health FSA Carryover: Tips and Traps

The IRS recently issued guidance modifying the “use it or lose it” rule, which has long been the most unpopular feature of health flexible spending accounts (health FSAs) commonly offered under a Section 125 cafeteria plan.

As a result of the change, set forth in Notice 2013-71,  individuals who participate in health FSAs, and who have not used their full budget of deferrals by the end of a given plan year may carry over up to $500 in unused funds to the next plan year.  (This discussion assumes a Sec. 125 cafeteria plan with the same plan year as the health FSA.)

Even if an employee carries over the full $500 amount, he or she may elect to defer the maximum amount currently permitted, $2,500, such that a health FSA may reimburse up to $3,000 in qualifying medical expenses in a given plan year (that, by necessity, follows a plan year in which no more than $2,000 in expenses were reimbursed).

Employers are eager to make use of this new feature, as the possibility of forfeiting even a small amount of hard-earned wages has kept significant number of employees away from health FSAs for years.  However there are some tips and traps that employers should consider before implementing the new plan feature.

  • Make a Choice.  First, an employer whose health FSA currently includes a grace period cannot implement the carryover feature alongside a grace period.  It is an “either or” choice.
    • A grace period is a period of up to 2 ½ months following the end of a plan year, during which prior year amounts may be used to reimburse expenses incurred during the grace period portion of the new plan year.
    • The main advantage of the grace period is that the full health FSA budget may be used within the grace period, whereas the carryover is limited to $500 (and employers may set a lower level if desired).   On the other hand, the grace period does not eliminate the hurried spend-down that occurs at the end of a cafeteria plan year, it just postpones it slightly.
    • By contrast, the carryover amount (up to $500) can be used at any time in the following cafeteria plan year and even in subsequent plan years, if no medical expenses require it be used in the interim.  Example 4 in Notice 2013-71 describes an instance in which $600 in unused funds from the 2014 calendar plan year, after reduction by $100 to meet the maximum carryover rule, is used to reimburse medical expenses in 2016.  Thus the carryover eliminates the spend-down scramble, but only for amounts up to $500.
    • Note that you do not need to eliminate a claim run-out period, if your plan includes one.  A claim run-out period is period following the end of a plan year, during which expenses incurred in the preceding plan year may be reimbursed using prior year amounts.  Teaming the claim run-out period with a carryover (or a grace period) requires some reimbursement ordering rules, which are discussed below under “Sequence Your Reimbursement Buckets.”
  • Timing is Everything.  For calendar year cafeteria plans, it is probably too late in the year to replace a grace period with a carryover, because employees may have scheduled procedures for after the first of the year that exceed $500 in out-of-pocket costs for the participant.
    • Because employees may have acted (or failed to act) in reliance on the grace period remaining in place, legal principles of “equity” and contract law would prevent employers from removing the feature at such a late date.  (The IRS Notice specifically references “non-Code legal constraints” that would apply; a similar concept is the “anti-cutback” rule applicable in the retirement plan sphere.)
    • Employer flexibility in this area may exist, including under non-calendar year plans, and even for calendar year plans depending on the number of participants in the health FSA and on participants’ forfeiture history.  If forfeitures consistently have been below $500 (which typically is the case), then dropping the grace period in favor of the carryover would allow employees additional time to spend the funds on medical expenses.
    • Employers must also be mindful of deadlines set forth in Notice 2013-71 for amending their cafeteria plans in relation to the carryover rule.  Amendments simply to add a carryover feature generally must be made before the last day of the plan year from which amounts are carried over.  However, only for amendments to add a carryover feature effective for the 2013 plan year (without eliminating a grace period), the amendment may be made by the last day of the 2014 plan year.  Amendments to remove a 2013 grace period (occurring early in 2014) must also be made by the last day of the plan year from which amounts may be carried over, retroactive to the first day of the plan year, but no transition relief is offered.  Therefore, an amendment to remove a grace period from the 2013 plan year, separately or in exchange for a new carryover feature, must be made by the end of the 2013 plan year, subject to the timing concerns raised above.
  • Communicate and Document.  A health FSA is an employee welfare benefit plan subject to ERISA documentation and disclosure duties.  The Notice requires plan sponsors that wish to add the carryover feature, either on its own, or in place of a grace period, to amend their cafeteria plan documents accordingly.  Plan amendments that make a material change to the contents of a cafeteria plan document must in turn be communicated to participants in the form of a written summary.  (Note:  generally this rule applies in the context of Summary Plan Descriptions (SPDs), and Summaries of Material Modifications (SMMs) to same.  However it is not uncommon for cafeteria plan documents, including health FSA components to be set forth in a single plan document without any abbreviated SPD.)
    • For a plan amendment simply adding a carryover feature, the written summary of the change must be furnished within 210 days after the end of the plan year in which the change was adopted.
    • For a plan amendment replacing a grace period with a carryover, a much shorter deadline applies:  the change must be communicated to participants in writing within 60 days after the date the employer adopts the change.

In either event, however, employers should try to provide the written summary of the change to employees as promptly as is possible, because the change likely will impact their health FSA spending before the mandatory notice periods have expired.

  • Sequence Your Reimbursement Buckets.  For your cafeteria plan to run smoothly you need to adopt “ordering rules” for reimbursing medical expenses.  It may be helpful to think of unused health FSA deferrals from the prior year as one “bucket” from which medical expenses may be reimbursed, and the new/current plan deferral amount as another “bucket.”  Important Note:  if your plan includes a claim run-out period, you will not know how much is in your “carryover” bucket until the claim run-out period has expired.  The carryover bucket can never hold more than $500.
  • One Possible Ordering Sequence:
    1. Apply prior year’s unused health FSA balance first to reimburse prior year expenses submitted during the claim-run out period.
    2. At the end of the claim run-out period, funds remaining in the prior year’s unused health FSA “bucket” are treated as follows:
      • Up to $500 remains in the bucket, which is now a carryover bucket.
      • Amounts exceeding $500 are forfeited.
  • Alternative Sequence.  The Notice also permits use of this alternative sequence:
    1. Apply current year unused health FSA balance first to claims incurred in the current plan year.  (Remember that under the uniform coverage rule, the maximum health FSA reimbursement budget elected by an employee is available to reimburse expenses as of the first day of a plan year, without regard to actual employee salary deferrals under the health FSA.)
    2. Apply prior year’s unused health FSA balance only after exhaustion of current year amounts.  Prior year unused amounts used to reimburse a current year expense (a) reduce the amounts available to pay prior plan year expenses during a claim run-out period, while applicable; (b) must be counted against the permitted carryover of up to $500, and (c) cannot exceed that maximum amount.

In either instance, current year health FSA funds may only be used to reimburse claims incurred in the current plan year, (except to the extent they remain unused at the end of a claim run-out period and are carried over to a subsequent plan year).

  • Beware of HSA Complications.  Tax-advantaged contributions to a Health Savings Account (HSA) may not be made by or on behalf of an individual who has coverage (as a participant or dependent) under a group health plan other than a high-deductible health plan (HDHP) (“disqualifying coverage”).  Eligibility under a health FSA that permits reimbursement of all expenses for medical care as defined in Code Section 213(d) is disqualifying coverage.  Coverage under a health FSA whose reimbursements are limited to dental and vision expenses, and or to other medical expenses incurred after the HDHP deductible amount is met, is not disqualifying coverage.  Notice 2013-71 does not address how the carryover feature impacts HSA eligibility.  Two possible approaches that representatives of the Groom Law Group informally have discussed with the IRS include restricting carryovers to a limited purpose health FSA, or permitting participants in general purpose health FSAs to opt out of participation in the health FSAs for years in which they want to preserve eligibility under an HSA arrangement.  Until further guidance is issued employers should assume that a participant who has a carryover balance under a general purpose health FSA, and his/her eligible spouse and dependents, will not be able to contribute to a health FSA while the carryover balance is available.

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Filed under Benefit Plan Design, Cafeteria Plans, ERISA, Flex Plans, Health FSA, Health Savings Accounts, Plan Reporting and Disclosure Duties

Significant Transition Relief for $2,500 Health FSA Limit

In Notice 2012-40 the IRS has provided meaningful transition relief on the effective date of the $2,500 annual spending limit, for employers whose health flexible spending arrangements (“health FSAs”) follow a fiscal year.   Most significantly, it makes clear that employers with fiscal year health FSAs may keep higher reimbursement limits in effect through the end of their 2012-2013 plan year, and that all employers may adopt retroactive amendments to impose the $2,500 limit at any time before December 31, 2014.

Currently the tax code does not impose a dollar limit on reimbursements under a health FSA.  The Affordable Care Act limits annual reimbursements – for the first time – to $2,500, effective for taxable years beginning after December 31, 2012. Specifically, cafeteria plans must provide that an employee “may not elect for any taxable year” to make salary reduction contributions in excess of $2,500.  As individuals are calendar year taxpayers, it was assumed that “taxable year” meant the calendar year, and thus that the $2,500 limit went into effect January 1, 2013.  This in turn generated confusion on applying the limit over a fiscal year that bridged that date.  The Notice resolves this matter, and provides additional guidance as outlined below:

  •  The term “taxable year” refers to the plan year of the cafeteria plan, not the individual participant’s tax year.
    • This means that reimbursement budgets that exceed $2,500 can remain in effect for a plan year beginning any time in 2012, including a December 1, 2012 – November 30, 2013 plan year.  The $2,500 dollar limit goes into effect for plan years beginning after December 31, 2012, meaning all calendar year plans as of January 1, 2013, and fiscal year plans beginning February 1, 2013 and subsequent.
    • This is a desirable result, but the Notice does not make the reasoning behind it very clear.   Basically it says that because the Affordable Care Act did not expressly state that the employer’s taxable year governed, the Service may now interpret “taxable year” to refer to plan years, including fiscal years.
  •  The $2,500 dollar limit will be indexed for cost of living adjustments for plan years beginning after December 31, 2013.
  • Employers whose health FSAs currently follow a calendar plan year may not change to a fiscal year “primarily” in order to delay application of the $2,500 reimbursement limit.
  • The Notice reminds that plan year changes must be for a “valid business purpose” (e.g., as a result of a merger or acquisition transaction) and any switch meant to delay application of the reimbursement cap will be disregarded (the original calendar year format will remain in effect).
  • The $2,500 limit must be prorated over a short plan year that begins after 2012.  For instance, a plan year beginning April 1, 2013 and ending December 31, 2013 may allow reimbursement of only $1,875 ($2,500 x .75)
  • The $2,500 limit applies on an employee-by-employee basis.  Thus, an employee who covers a spouse and several dependents under a group health plan must fit reimbursements for the whole family within a single $2,500 budget.  Conversely, if each of two spouses may participate in a health FSA as employees, they each are entitled to a $2,500 budget even if they both participate in the same health FSA sponsored by the same employer.
  •  The $2,500 limit applies on a “controlled group” basis.  If an employee performs services for several corporations elated by ownership (e.g., parent – subsidiary) and participates in multiple health FSAs, the employee’s total health FSA budget under all cafeteria plans within the “controlled group” of corporations is limited to $2,500.  The same would be true if the related businesses were partnerships or LLCs under “common control,” and also under “affiliated service group” rules.
  •  Conversely, if an employee performs services for several employers that are not related by ownership at the requisite “controlled group” levels, the employee may enjoy a separate $2,500 budget under each employer’s health FSA.
  • With regard to employer contributions under a cafeteria plan, often called “flex credits,” the flex credits will count towards the $2,500 (and reduce the employee’s salary deferral limit) if the employee can elect to receive the flex credits as cash or as a taxable benefit.  Flex credits that are only usable in the health FSA for reimbursed medical expenses will not offset the $2,500 limit, however.
  • The $2,500 limit only applies to health FSA reimbursements and not to salary reduction contributions to any of the following:
    • Dependent care reimbursement accounts
    • “Premium only” or premium conversion portions of a cafeteria plan
    • Health Savings Accounts
    • Health Reimbursement Accounts (technically, treated as employer contributions).
  • Unused salary reduction contributions to a health FSAs that are carried over after the end of a plan year into a grace period (not to exceed 2 ½ months into the subsequent plan year) do not count against the $2,500 limit applicable for the subsequent plan year.
  • The Notice provides a self-correction procedure that an employer may use when, despite timely amendment of the plan to impose the $2,500 limit, one or more employees exceeds the limit.  The conditions for self-correction are as follows:
    • The terms of the plan apply uniformly to all participants (a requirement of proposed cafeteria plan regulations from 2007).
    • The excess reimbursements were the result of a reasonable mistake by the employer and not due to willful neglect.
    • Reimbursements that exceed the $2,500 limit are paid to the employee as wages and reported on Form W-2 for the calendar year that includes the end of the cafeteria plan year in which the correction takes place.
    • The employer’s federal tax return must not be under audit for cafeteria plan issues for any plan  year in which the dollar limit was exceeded.
    • Self-correction presumably will be on an “honor system,” for, as I noted in an earlier post, the IRS will not be able to track health FSA reimbursement amounts via Form W-2 reporting of health care costs.
  •  A retroactive cafeteria plan amendment to impose the $2,500 reimbursement limit may be adopted at any time before December 31, 2014, provided that the plan has been operated in compliance with the dollar limit during the interim period.   Illustrations in the Notice make clear that his relief is available even to employers with calendar year health FSAs; i.e. an amendment could be adopted on December 31, 2014 that takes effect January 1, 2013.

The Notice requests public comment on whether modifications to the “use-it-or-lose-it” rule are in order given the new dollar limit on annual reimbursements.  The use-it-or-lose-it rule was meant to prohibit (mis)use of a flex plan to defer compensation from one year to another but that goal largely is served by the cap on reimbursements.  Thus the Service seeks comments on “different form[s] of administrative relief” from the use-it-or-lose-it rule, instead of or in addition to the 2½ month grace period rule.

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Filed under Affordable Care Act, Cafeteria Plans, Flex Plans, Health FSA, PPACA

Update on Fiscal Year Health FSAs and the $2,500 Limit

On January 10, 2011 I posted about how employers with health FSAs that follow a fiscal year might comply with the $2,500 deferral dollar limit going into effect on January 1, 2013. This post updates and corrects the earlier post as follows:
Notice 2012-9, which provides updated guidance on Form W-2 reporting of the value of group health care, exempts most health FSAs from the reporting requirement. The specific exemption applies to health FSAs that are exempt from HIPAA because they are funded entirely by employee salary deferrals, or because any employer contribution is $500 or less. (W-2 reporting of health care is waived entirely for employers filing fewer than 250 Forms in 2013, based on 2012 employment figures.)
• As a consequence, the IRS will not be able to monitor, through tax returns, any instances in which employee salary deferrals in 2013 exceed the $2,500 limit.
• One of the proposed approaches described in my January 10 post – namely, stopping deferrals at the $2,500 mark – would violate the requirement, set forth in the 2007 Proposed Regulations, that employee salary deferrals be taken in intervals that are uniform for all participants, which in turn potentially could disqualify the plan. (Proposed Treas. Reg. § 125-5(g)(2)). It is possible the IRS will address this method in future guidance but until such time it is not recommended.
• Another proposed method – “front-loading” the 2012-2013 deferral amount so that only $2,500 is deferred in the 2013 portion of the fiscal year – would not expressly violate Section 125 regulations because they do not require deferrals be made in uniform amounts, only uniform intervals. However this method could be viewed as inconsistent with the spirit, if not the letter, of the uniform coverage rule, which prohibits timing deferral payments based on the rate or amount of covered claims incurred. Front-loading is also arguably inconsistent with the uniform deferral rate requirement. An employer could also pro-rate the higher 2012 deferral amount and the lower 2013 deferral amount across the 12 month fiscal year but this would require that the employer reduce deferrals in the first half of the 2013-3014 fiscal year to equal $2,500, when combined with the pro-rated deferrals during the latter half of the 2012-2013 fiscal year. Clearly, timing of the fiscal year start (whether early in 2013, or late in the year) may make the front-loading or pro-rated options unaffordable for some participants.
• Even if unequal deferral amounts are permitted, the actual functioning of the pro-rated or front-loaded method could result in violation of Section 125’s nondiscrimination rules, specifically the rule that key employees receive no more than 25% of aggregate tax qualified benefits under a plan in any given year. This easily could occur if, for instance, shareholders and executives of a business typically were the only participants who deferred in excess of $2,500 per year, and continued to defer $5,000 per year under the pro-rated/front-loading method.
• The third method mentioned in my earlier post – imposing the $2,500 deferral cap at the start of the 2012-2013 fiscal year, is the most conservative approach to take but also the approach that will be most unpopular with participants who are accustomed to deferring significant amounts of money in prior plan years.
• At this point, any further guidance from the IRS would only be useful for employers whose fiscal years begin March 1 or later, as February 1 start date plans are almost through open enrollment. It may well be that the Service recognized that sponsors of fiscal year health FSAs would face administrative and legal obstacles to implementing the $2,500 limit and decided that the less the said about the matter, the better.

I want to thank my client and good friend Mike Igoe of Igoe Administrative Services in San Diego, California, for providing the ideas and impetus behind this post. There are very few true experts in this area, but Mike is one of them. Thanks, Mike.

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Filed under Cafeteria Plans, Flex Plans, Health FSA, Payroll Issues

Health FSA Dollar Limit for 2013 Impacts Some Fiscal Year Plans Now

The Affordable Care Act limits salary deferrals that may be made under a health flexible spending account (FSA) to $2,500 in “taxable years” beginning on or after January 1, 2013. However Section 125 cafeteria plans that include health FSAs subject to the dollar limit, and that follow a fiscal rather than calendar plan year, need to take steps now to apply the dollar limit over their 2012 – 2013 plan year.

That is because, for purposes of the 2013 dollar limit, the term “taxable year” refers not to the plan year but to the taxable year of the employee participating in the health FSA. Almost universally, this will be the calendar year. The first fiscal plan year that will overlap with 2013 begins February 1, 2012 (ending January 31, 2013). Fiscal year plans that currently permit salary deferrals in excess of $2,500 must ensure that deferrals occurring over the 2013 calendar year do not exceed the $2,500 cap.

For instance, a plan that follows an April 1 – March 31 fiscal year and currently permits a maximum health FSA reimbursement of $6,000 would ordinarily allow participants to defer $500 per month under the plan. For the plan year beginning April 1, 2012 and ending March 31, 2013, this would permit salary deferrals of up to $1,500 to occur between January 1, 2013 and March 31, 2013. A participant deferring the maximum amount in the current plan year would be limited to deferring $1,000 over the balance of the 2013 calendar year (April through December), or only $111.11 per month.

We do not yet have any specific guidance from the IRS on applying the new dollar limit to a fiscal year plan, and the pro-rata method described above is only one option.

Other options might include (a) allowing the current rate of deferrals to continue into 2013, but cutting them off as soon as they reach the $2,500 dollar limit, and (b) imposing the $2,500 dollar limit as of the beginning of the 2012-2013 fiscal plan year. One trusted research source, EBIA’s Cafeteria Plans (©2011 Thompson-Reuters) mentions “front-loading” the deferrals during 2012, so that the “old” budget is met even while deferrals made during the 2013 year stay within the new dollar limit. Even were the IRS expressly to sanction the front-loading approach, it might not be financially workable for employees, particularly under fiscal year plans that begin late in the calendar year. Although guidance from the IRS is needed on this and a number of other transition compliance points, employers with early fiscal year starts do not have the luxury of waiting much longer.

Whichever transition method is chosen, employers promptly should communicate their choice to plan participants and work closely with their payroll departments, or their third party payroll providers, to ensure that they transition smoothly into the new dollar limit applicable January 1, 2013 and beyond.

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Filed under Affordable Care Act, Cafeteria Plans, Flex Plans, Health FSA, PPACA