When can an employee change his or her elections within a Section 125 plan?
Under a Section 125 (or cafeteria) plan, participant elections generally must be irrevocable until the beginning of the next plan year. However, when a participant experiences one of several specific recognized events, he or she may be permitted to make a change in election that is consistent with the event. A change in election must be made prospectively, except in the few cases where HIPAA requires that a change be made effective retroactive to the date of the event.
A Section 125 plan may allow a participant to change his or her elections related to accident and health coverage and group term life insurance upon the occurrence of any of the following events:
- Change in status (employee’s legal marital status, number of dependents, employment status – including change in worksite location, dependent satisfies eligibility requirements, change in residence, commencement/termination of adoption proceedings)
- Significant cost increase
- Significant curtailment of coverage
- Addition or elimination of benefit package option
- Change in coverage of spouse or dependent under other employer’s plan
- FMLA leave
- COBRA event
- Judgment, decree or court order
- Medicare or Medicaid entitlement
When can I change the amount contributed to my Section 125 Dependent Care Flexible Spending Account?
Under a Section 125 plan, participant elections generally must be irrevocable until the beginning of the next plan year. In some cases, a participant is permitted to make a mid-year change in election. For example, a mid-year election change is permitted when:
- A change in status occurs that impacts the dependent’s eligibility under the employer’s plan.
Example: In the event of divorce, the election may be revoked in the event the employee does not have physical custody of the child.
- An increase in the cost of dependent care occurs, so long as the dependent care provider is not a relative of the employee.
- A change in status occurs that affects eligibility of dependent care expenses for tax exclusion.
Example: An election may be modified where a dependent turns age 13 in the middle of the Section 125 plan year.
Under this rule, it is also likely that some changes in employment status might allow a mid-year election change. For example, an employee taking a leave of absence or moving from full-time to part-time status would be permitted to change their election to correspond with the allowable tax exclusion.
When can I change the amount contributed to my Section 125 Health FSA?
A plan participant is permitted to make a mid-year election change following a change in status (e.g., change in marital status such as marriage or divorce, change in the number of dependents such as a birth or adoption, or change in employment status such as termination or commencement of employment). A plan participant may also change his or her elections at the beginning and end of an FMLA leave.
The IRS rules, however, do not allow plan participants to change their Health Flexible Spending Account (Health FSA) election as a result of a change in cost or coverage.
What expenses can be reimbursed under a Section 125 Health Flexible Spending Account?
To be reimbursable under a Health Flexible Spending Account (Health FSA), the expense must be for medical care as defined in IRC 213. Eligible medical expenses must be incurred:
- During the current Health FSA plan year, and
- By the employee, employee’s spouse or dependent.
Effective January 1, 2011, employees with a Health FSA can no longer use their account funds to purchase over-the-counter (OTC) drugs and medicines unless they have a prescription for those drugs from their doctor or the drug is insulin.
IRS Publication 502 provides some guidance on eligible medical expenses that may be reimbursed under a Health FSA.
Can a Section 125 plan provide a grace period?
Yes. Section 125 plans can provide a grace period of up to 2 ½ months after the end of a plan year. During this grace period, participants can access unused amounts for reimbursement of expenses related to qualified benefits, such as health FSA or DCAP expenses, for expenses incurred during the grace period. These expenses are treated as though they had been incurred prior to the end of the plan year.
A cafeteria plan is not required to offer a grace period or can choose to offer a shorter grace period than 2 ½ months. However, if the plan sponsor chooses to provide a grace period, it must make sure that the plan document is amended to provide the grace period. It must also make sure that the grace period applies to all participants who participated in the plan on the last day of the plan year (including COBRA participants).
A grace period should not be confused with a “run-out period.” A run-out period only extends the deadline for submitting expenses for reimbursement. For example, the ABC Co. cafeteria plan contains a 30 day run-out period, but does not include a grace period. The plan year ends on December 31. Due to the run-out period, participants have an extra 30 days after December 31 to submit claims for expenses that were incurred prior to December 31.
What happens if an employee quits and that employee has overspent their Section 125 Health Flexible Spending Account?
The employee may not be required to reimburse the health FSA for any amount owed at the time of termination. It is the IRS’ position that a health FSA “exhibit the risk-sharing and risk-distribution characteristics of insurance.” In order to reduce the employer’s risk of loss, an employer may a) impose an annual limit on the amount that can be set aside in a health FSA or 2) require that an employee serve a waiting period before he or she is eligible to contribute to a health FSA.
What happens if an employee quits and that employee has underspent their Section 125 Health Flexible Spending Account?
When an employee has underspent their account at the time of the qualifying event, the employee is entitled to elect to continue the health flexible spending account under COBRA for the remainder of the Section 125 plan year. However, the employee is not entitled to continue their contributions to the health flexible spending account during the full period of COBRA continuation coverage (e.g., 18 months). According to the Internal Revenue Service “the purposes of COBRA are not furthered by requiring an employer to offer COBRA for a plan year if the amount that the employer could require to be paid for COBRA coverage for the plan year would exceed the maximum benefit that the qualified beneficiary could receive under the health flexible spending account.”
Example: Under a Section 125 plan, an employer offers its employees a traditional medical insurance plan and allows its employees to contribute pretax dollars to a health FSA. Employee elects to contribute $2,000 during the 2000 calendar year. Employee terminates his employment effective July 1, 2000. To date, employee has not sought reimbursement from his health FSA. Under COBRA, this employee is entitled to continue his health FSA through the end of December 2000.
Can an employee change his or her elections when taking FMLA leave?
Yes. The commencement of FMLA is an event that allows an employee to revoke their existing Section 125 elections, including health and dependent care Flexible Spending Account elections.
The employee’s return from work following FMLA is also an event that allows an employee to modify their Section 125 elections, including health and dependent care Flexible Spending Account elections.
How are employee contributions made during FMLA leave?
While on FMLA leave, an employee may be permitted to pay their employee contributions on a pretax basis in one of three ways:
- Pre-pay the amount that would be owed during FMLA leave (provided the FMLA leave does not extend past the end of the Section 125 plan year),
- Pay the amount that is due each month while on FMLA (if receiving disability or vacation pay during leave), and
- Catch up on contributions upon return from leave.
If an employer significantly reduces coverage during the middle of the Section 125 plan year, can an employee change his or her elections?
Yes. If the employer significantly reduces coverage, affected plan participants may
- Revoke their existing election and/or
- Elect another similar plan, if available.
As with most election changes, the change must be consistent with the event and be made effective going forward.
In the past, health plan coverage must have been provided by an independent third party in order for plan participants to be allowed to make a mid-year change in election following a significant reduction in coverage. Thus, self-funded plans were not able to allow mid-year election changes following a significant change in benefits. Under the proposed rules, self-funded plans may now take advantage of the cost or coverage change rules.
Note: The rules do NOT allow a mid-year election change to a health FSA in response to a significant reduction in coverage.
If an employer adds or eliminates a benefit option during the middle of the Section 125 plan year, can an employee change his or her elections?
Yes. If an employer adds or eliminates a benefit option during the middle of the Section 125 plan year, affected plan participants may make a corresponding change in their election. The change in election must be consistent with the event and be made effective going forward.
Do the IRS (Section 125) rules related to claim substantiation permit use of debit cards with a health FSA?
Yes. The IRS has provided guidance on how claim substantiation requirements can be met when a debit card is used with a health FSA (Revenue Ruling 2003-43 ).
Eligible medical expenses can be reimbursed from a health FSA with a debit card when:
- Participants certify upon enrollment and reaffirm upon each use of the card, as printed on the back of the card, that the card will only be used for eligible medical expenses;
- Reimbursement for medical expenses are processed only if they originate with certain vendors having health care-related merchant category codes (MCC);
- Each claim is reviewed or substantiated, either automatically without additional documentation or manually through the submission of merchant or service provide receipts; and
- Meaningful correction procedures for claims that are subsequently identified as impermissible are adopted.
Automatic claims substantiation includes three categories: a) transactions that equal the exact amount of the copayment for the service under the participant’s health plan, b) recurring expenses that match previously-approved expenses (e.g., prescription refills) and c) charges that were substantiated at the point of sale (“real-time substantiation”) by receipt of information from the service provider. No further documentation for claims that fit into these categories is required.
The IRS also requires that a) participants retain documentation for any expense paid with a debit card, b) that the debit card be cancelled immediately upon a participant’s termination of employment and c) payments made to a medical service provider for more than $600 in a tax year through the use of debit card be reported on a 1099-MISC.
Note: The claim substantiation requirements cannot be met by simply sampling claims to determine if the reimbursement was appropriate.
In 2006, the IRS provided additional guidance regarding electronic payment cards in the form of IRS Notice 2006-69 which allows auto-adjudication of card transactions at merchants without health care-related MCCs, so long as an inventory information approval system is in place to ensure that cards are used only for eligible medical care expenses and certain recordkeeping requirements are met. It also permits auto-adjudication of certain transactions at merchants with health care-related MCCs involving multiple copayments.
IRS Notices 2007-2 and 2008-104 provide transition relief for certain merchants without health care-related MCCs, as well as additional restrictions for certain stores with the “drug stores and pharmacies” MCC. Beginning July 1, 2009, health FSA electronic payment card use must be limited to the following three categories of merchants:
- physicians, dentists, vision care offices, hospitals and other medical care providers (as identified by MCC);
- stores with the “drug stores and pharmacies” MCC that, on a location-by-location basis, meet the 90 percent gross receipts test (we call these “qualifying pharmacies”); and
- stores that have implemented an inventory information approval system.
Participants must agree in writing before receiving a card that they (1) will only use the card to pay for their eligible medical care expenses (and those of their spouses and dependents), (2) will not use the card for expenses that have already been reimbursed, (3) will not seek reimbursement under any other health plan for expenses paid for with the card and (4) will acquire and keep sufficient documentation (e.g., invoices and receipts) for expenses paid with the card. In addition, the card must include a statement that these agreements are reaffirmed each time the participant uses the card. Thus, each time the card is used, the participant is affirming that the expense is eligible for reimbursement and will not be reimbursed elsewhere.
Under Section 125, can an employee make a mid-year election change that corresponds with elections a spouse made during their employer’s open enrollment period?
Yes. An employee may make a mid-year election change that corresponds with elections a spouse made during his or her employer’s open enrollment period. However, the change in election must be consistent with the elections made by the spouse and be made effective going forward. The rules do not permit a mid-year election change to a health FSA election.
Example: Employee works for Employer A. Employer A’s Section 125 plan runs January through December. During the last open enrollment, employee waived medical and dental coverage.
Employee’s spouse works for Employer B. Employer B’s Section 125 plan runs August through July. When first hired, the employee’s spouse elected family coverage under the medical and dental plans. During the most recent open enrollment period, the spouse chose not to elect coverage under Employer B’s plan.
Employer A may allow its employee to elect family coverage under the medical and dental plans offered by Employee A.