NEWSLETTERS

On March 23, 2000, the IRS published new guidance which provides flexibility in the rules for when a tax code Section 125 cafeteria plan election can be changed.

The guidance, which affects employers who maintain cafeteria plans and beneficiaries and participants in those plans, was issued in the form of final regulations (T.D. 8878) and a notice of proposed regulations (REG. 117162-99).

The integrated package of the final and proposed regulations, aim to provide clear standards for plan administration and for administration of the tax law, as well as clarify the circumstances under which a cafeteria plan may permit an employee to change his or her cafeteria plan election with respect to accident or health coverage or group-term life insurance coverage during the year.

According to the IRS, "The standards are designed to accommodate the most common types of events of independent significance that do not occur on a regular, periodic basis which are likely to affect an employee’s decision with response to qualified benefits coverage.

The final regulations, which basically follow the temporary regulations which were issued in 1997 (25 BPR 2472), include examples of how the rules apply in specific situations. The new proposed regulations expand upon the approach taken in the 1989 proposed regulations and include examples of how to apply the rules.

Cafeteria plans are benefit plans offered by employers under which eligible employees can choose between cash and certain qualified benefits, such as health and accident insurance, group-term life insurance, health and dependent care flexible spending accounts, and adoption assistance.

Under tax code Section 125, employees generally may choose a non-taxable benefit rather than the available cash without having to include the available cash in gross income.

The final regulations reflect two principal changes that were made in response to public comments on change-in-status events. They differ from the 1997 regulations by expanding the description of change-in-status, to include work-related changes of an employee, the employee’s spouse, or the employee’s dependent, such as a strike or lockout, and commencement or return from an unpaid leave of absence.

As under the 1997 temporary and proposed regulations, the final regulations require that an election change as a result of a change-in-status also satisfy a consistency requirement.

The consistency rule in the final regulations requires that an election change made pursuant to a change in status be "on account of" a gain or loss of eligibility for coverage.

In the event of a change in an employee’s marital status or the employment status of an employee’s spouse or dependent, the final regulations permit the employee to elect to increase or decrease group-term life insurance coverage.

Specifically, the final results incorporate a more flexible rule for other change in employment status events, so that if a change in employment status of an employee (or spouse of a dependent of the employee) occurs that affects that individuals’ eligibility under a cafeteria plan or a qualified benefits plan, that change would constitute a change in status. The IRS also said that a similar rule applies with respect to disability income plans.

Moreover, consistent with the approach taken in the 1997 regulations, the final regulations do not prescribe a period of time by which election changes, as a result of a change-in- status, should be made. The IRS also noted that the final regulations would not prevent a cafeteria plan by its terms from requiring that any election change other than those made in connection with rights for which there are specific minimum election periods, must be made within a specified period after a change-in-status event.

The final regulations did not address when a bona fide termination of employment occurs, but instead retained the example from the 1997 temporary and proposed regulations addressing the situation in which an employee terminates and resumes employment within thirty days.

In the example, IRS said that if an employee terminates and resumes employment within thirty days and the cafeteria plan provides that the employee’s election is automatically reinstated, the employer is not required to determine whether a bona fide change in status has occurred with respect to termination of employment.

According to the final regulations, "The effect of this example is to provide a practical safe harbor that generally may be applied by cafeteria plans without regard to other facts and circumstances".

The proposed regulations (REG 117162-99) provide significant cost and coverage changes for all types of qualified benefits provided under a cafeteria plan. According to the IRS, "these new rules apply only if the change made by the employee is on account of and corresponds with the change made under the other employee’s plan". They also stated, "this expansion of the existing cost or coverage change rules permit employees to make election changes to ensure consistent coverage of family members and eliminate duplicate coverage."

The new proposed regulations provide the following:

• Allow a mid-year cafeteria plan election change in connection with dependent care assistance and adoption assistance under change-in-status standards in the final regulations for accident or health plans and for group-term life insurance, and by adding change-in-standards that are specific to dependent care and adoption assistance.

• Should a plan add a benefit plan option, such as a new health maintenance organization option, the cafeteria plan may permit affected participants to elect that option and make a corresponding election change with respect to other benefit package options during a period of coverage.

• Extend the cost or coverage rules to permit election changes for self-insured accident or health plans, group-term life insurance, dependent care assistance, and adoption assistance coverage under a cafeteria plan.

• A spouse makes an election change during an open enrollment period, a corresponding change should be permitted for the other spouse. In response to these recommendations, the proposed regulations indicate that a cafeteria plan may permit an employee to make an election change during a period of coverage, corresponding with an open enrollment period change made by a spouse or dependent, when the plan of that individual's employer has a different period of coverage.

• A cafeteria plan may permit an employee to make an election change in the event that a spouse or dependent makes an election change under a cafeteria plan or qualified benefit plan maintained by that individual’s employer, if the spouse or dependent’s election change satisfies the election change rules under the proposed regulation.

Under the final regulations, a dependent means a dependent as defined in tax code Section 152, which excludes those individuals who do not qualify for a dependent deduction on the employee’s tax return, including domestic partners and parents.

The final regulations are applicable for cafeteria plans beginning on or after January 1, 2001. However, in the interim, IRS said practitioners may rely on the final regulations, the change-in-status rules in the 1997 regulations, as well as the change-in-family-status rules in the pre-1997 proposed regulations.

The proposed regulations do not specify a proposed effective date. IRS said any effective date will be prospective. According to the IRS, until the effective date of further guidance, taxpayers may rely on the new proposed regulations.

© Administrative Retirement Services, Inc.  2001
Published by Administrative Retirement Services, Inc., Copyright 2001 by Administrative Retirement Services, Inc. Reproduction in whole or in part is prohibited except by written permission. All rights are reserved.  Information has been obtained by Administrative Retirement Services, Inc. from sources believed to be reliable. However, because of the possibility of human or mechanical error by our sources, Administrative Retirement Services, Inc. or others, Administrative Retirement Services, Inc. does not guarantee the accuracy, adequacy, or completeness of any information and is not responsible for any errors or omissions or the result obtained from the use of such information.  Readers should seek specific advice before acting with regard to the subjects mentioned here.

back