Need to Know Issues with Flexible Spending Accounts

Presented by
Larry Grudzien | Attorney at Law

Agenda
• Allowable Election Changes
• Carryovers
• COBRA
• HRAs & FSAs
• HSAs & FSAs
• Health Reform Issues
• Dealing with mistakes

ALLOWABLE ELECTION CHANGES
FOR HEALTH FSAS

Mid-Year Election Changes
• General irrevocability rule - no change required
for the plan year.
• 5 events are recognized by the IRS as permitting
mid-year election changes for health FSAs.
• Other events are recognized permitting mid-year
election changes.
• Administrative requirements that must be met to
implement a mid-year election change.

5 Events for Mid-Year Election Changes For Health FSAs
1. Change in Status
2. COBRA Qualifying Event
3. Judgment, Decree, or Order
4. Entitlement to Medicare or Medicaid
5. FMLA Leave of Absence

1 | Change in Status
These changes include:
 Employee’s marital status
 Number of dependents
 Employment status
 Dependents satisfying or ceasing to satisfy
dependent eligibility requirements
 Residence
 Commencement or termination of adoption
proceedings
Note: The plan document must include a provision for each
of the above events the employer wishes to allow.

1 | Change in Status – Marital Status
Change in marital status includes
 Marriage
 Divorce
 Death of Spouse
 Legal Separation
 Annulment.

1 | Change in Status – Number of Dependents
Change in the number of dependents
 Birth,
 Adoption,
 Placement for adoption, and
 Death.
Note: Dependent is defined as a dependent under Code
§105(h)
For Dependent Care Plans, a dependent means an
individual eligible for the dependent care tax credit defined
in IRC §21(b)(1).

1 | Change in Status – Employment Status
Change in Employment Status
 Termination or commencement of employment,
 Strike or lockout,
 Commencement or return from unpaid leave of absence,.
 A change in work site, and
 Change in employment status causing a change in eligibility
under the plan (example – if the plan covers only salaried
employees and the employee becomes hourly).
Note: Any of the above events that change the employment status
of an employee, the employee’s spouse or the employee’s
dependents would qualify as a change in status.

1 | Change in Status – Dependent Eligibility
Dependents satisfying or ceasing to satisfying
dependent eligibility
 Attainment of age
 Marriage or any other similar circumstances
Note:The individual must be under Code § 105(h).

1 | Change in Status – Change in Residence
Change In residence
 Change in the place of residence of an employee,
spouse or dependent.
 Change of residence would have to change the
eligibility for health coverage.
 Coverage may be dropped where the change affects
eligibility for a managed care option (even if the
employee could elect similar coverage).

1 | Change in Status – Consistency Requirement
If a change in status event occurs, a plan can only permit
employees to make election changes that are consistent
with the event.
There is one “general consistency rule” and 4 special
consistency rules.
 Group Term Life, Disability, and Dismemberment Coverage.
 Dependent Care and Adoption Expenses.
 Loss of Spouse’s or Dependent’s Eligibility.
 Gain of Eligibility under another Employer’s Plan.

• A participant may increase or decrease group
term life, disability and dismemberment
coverage for any change in status event, even
through eligibility under the plan is not gained or
lost.
• The occurrence of the event is enough.
• Check the insurance contract to determine
wither the event is allowed.
Group Term Life, Disability, and Dismemberment Coverage

• This rule is satisfied if the election change on
account of and corresponds with a change in
status that affects eligibility of dependent care or
adoption assistance expense for tax exclusions
available under tax code.
• Election may be canceled when an employee’s
child turns 13 in the middle of the a plan year
and is no longer a qualifying individual.
• An employee’s or a spouse’s leave of absence
or other change in employment status could also
trigger this rule.
Dependent Care and Adoption Expenses

• An employee can cancel accident or health
coverage for only the spouse or dependent.
• An election to cancel coverage for anyone else
fails to correspond with that change in status.
• May create a hardship under plans that offer
limited coverage categories.
Loss of Spouse’s or Dependent’s Eligibility

If coverage is gained as a result of a change in
marital or employment status, then an employee’s
election to cease or decrease coverage for that
individual corresponds with the change in status if
coverage for that individual becomes effect or is
increased under the other employer’s plan.
Gain of Eligibility under another Employer’s Plan

• If one of the 4 special rules do not apply then the
general consistency rule applies.
• Under this rule, an election change satisfies the
consistency requirement “if the election change is on
account of and corresponds with a change in status
that affects eligibility for coverage under the employer’s
plan.”
• The rule includes 2 elements:
 The change in status event must affect eligibility for
coverage under the employer’s plan.
 The election change must be on account of and correspond
with the event.
General Consistency Rule

The change in status event must affect eligibility
for coverage under the employer’s plan.
 Gain or loss of coverage eligibility under the
component benefit plan or the cafeteria plan will
satisfy the consistency requirement.
 A change in status that affects eligibility includes the
increase or decrease of the number of an
employee’s family member or dependents who
benefit from coverage under the plan.
General Consistency Rule - Elements

The election change must be on account of and
correspond with the event:
 If one type of coverage is lost or gained, then the
employee is limited to changing an election with
respect to that coverage.
 Other eligible individuals can also be added when a
spouse or dependent gains eligibility as a change in
status event.
 If an employee was no previous enrolled and a
change in status occurs this rule will also allow the
employee to enroll in order to enroll the dependents.
General Consistency Rule - Elements

2 | COBRA Qualifying Event
A cafeteria plan may permit an employee to make
a mid-year election change if a COBRA event
occurs to the employee, spouse or dependent.
Employee may increase pre-tax salary reductions
to cover the COBRA premiums.
Example:
Employee has reduction of hours triggering a COBRA
event.
He can increase pre-tax salary reductions to cover cost
of COBRA premiums.

3 | Judgment, Decree, or Order
A cafeteria plan may allow mid-year changes on
account of judgment decrees and orders resulting
from divorce, legal separation, annulment, or
change in legal custody.
Example:
An employer receives a qualified medical child support
order (QMCSO) requiring the employee to cover a
dependent child.
The employee is allowed to change his election in order
to cover the child.

4 | Entitlement to Medicare or Medicaid
• A cafeteria plan may allow mid-year election
changes on account of eligibility of the
employee, spouse or dependent for Medicare or
Medicaid.
• Gaining Medicare or Medicaid allows participant
to cancel or reduce FSA amount .
• Losing Medicare or Medicaid allows participant
to elect or increase the FSA amount.

5 | FMLA Leave of Absence
• A cafeteria plan may allow a mid-year election change on account
of a leave of absence under FMLA.
• Employer must allow all the election changes available to
employees on non-FMLA leave.
• The plan must allow participant to revoke health care coverage if
he so wishes.
• Employee can reinstate coverage upon return from leave.
• If employee continues coverage during an FMLA leave, employer
may allow three types of payment options: pre-pay, pay-as-you
go or catch-up.
• These rules apply to health care FSA plans and uniform coverage
rule still applies

Other Events That Might Permit Mid-Year Elections
• Military leave under USERRA.
• Mistakes made by employee or employer.
• Participant Fails Medical Underwriting.
• Mid –year election changes may be required to
pass non-discrimination testing.
• Automatic loss of coverage.

Administrative Requirements for Mid-Year Election Changes
• Obtain substantiation for reasons for the change.
• Decide when the election can be effective.
• Confirm that cafeteria plan regulations allow the
change.
• Confirm that plan document and insurance
policies allow the election.

What is allowed?
• IRS guidance issued in October 2013 allows health FSAs to offer
carryovers of unused balances of up to $500 remaining at the end
of a plan year, to be used for qualified medical expenses incurred
in subsequent plan years.
• Offering health FSA carryovers is optional and is an alternative to
offering a health FSA grace period—health FSAs allowing
carryovers from a plan year cannot also have a grace period with
respect to that year.
• This exception to the use-or-lose rule offers the potential to
reduce health FSA forfeitures, which may encourage more
employees to participate in health FSAs.

What is allowed?
• Amounts carried over are available to reimburse
eligible medical expenses incurred in a subsequent
plan year.
• Offering health FSA carryovers is optional, and plan
sponsors wishing to allow carryovers must specifically
provide for carryovers in their plan documents.
• If carryovers are offered, the same carryover limit
must apply to all participants.
• The uniform coverage rule will continue to apply to a
health FSA that offers carryovers.

What is allowed?
• The amount that an employee can carry over is based
on the health FSA amount remaining from a plan year
at the end of the run-out period for that plan year (i.e.,
after all expenses for that plan year have been
reimbursed).
• At that time, unused health FSA amounts from the plan
year in excess of $500 (or a lower amount, if
applicable under plan) are forfeited, and the remaining
amounts can be used to reimburse eligible expenses
incurred during the new plan year.

What is allowed?
• During a health FSA’s run-out period, potential carryover
amounts may be used either for prior-year or current-year claims,
although no more than $500 in potential carryovers can be used
to reimburse current-year expenses.
• During this time, plans may reimburse current-year claims first
from current-year amounts.
• While this ordering rule is permissive, it appears to be a best
practice.
• Using current-year contributions first leaves potential carryover
amounts available to reimburse prior-year expenses submitted
during the run-out period.
• Conversely, reimbursing current-year claims from potential
carryover amounts during the run-out period will reduce the
amount available to pay run-out claims from the prior year.

Additional Issues Raised by Carryovers
• How Do Carryovers Affect HSA Eligibility?
• Will Carryovers Affect a Health FSA’s Status as
an Excepted Benefit?
• What COBRA Issues Are Presented by
Carryovers?
• W-2 Reporting
• Other Administrative and Compliance Issues

Does COBRA Apply?
• Health FSAs are group health plans and thus are subject to
COBRA, unless maintained by a small employer, a church, or the
federal government.
• Health FSAs that are subject to COBRA must offer COBRA
coverage to qualified beneficiaries who lose coverage as the
result of a qualifying event, unless the special limited COBRA
obligation and must provide all required COBRA notices, including
initial notices and election notices.
• IRS representatives have informally indicated the IRS view that
family members other than the covered employee are entitled to
elect COBRA under a health FSA in connection with an
employee's termination of employment.

Limited COBRA Obligation for Certain Health FSAs
If a health FSA meets certain conditions prescribed in the
IRS COBRA regulations, the obligation to offer COBRA
coverage is limited, as follows:
COBRA coverage need not be offered to qualified beneficiaries
who have “overspent” their accounts as of the date of the
qualifying event.
For those with underspent accounts, COBRA must be offered,
but may be terminated at the end of the year in which the
qualifying event occurs (a qualified beneficiary receiving
COBRA coverage at that time would also be entitled to any
grace period provided under the plan).

Which Health FSAs Qualify?
To qualify, a health FSA must provide excepted benefits; and the
COBRA premium under the health FSA must meet certain
minimums.
Benefits provided under a health FSA “are excepted for a class of
participants” if the health FSA is an FSA as defined in Code §106(c)
(2) and satisfies the following two conditions:
Condition #1—Maximum Benefit Condition. The maximum benefit payable
under the health FSA to any participant in the class for a year cannot exceed
two times the participant's salary reduction election under the health FSA for
the year (or, if greater, the amount of the employee's salary reduction election
for the health FSA for the year, plus $500).
Condition #2—Availability Condition. Other group health plan coverage, not
limited to benefits that are excepted benefits (e.g., limited-scope dental and
vision coverage), must be made available for the year to the class of
participants by reason of their employment.

Which Health FSAs Qualify?
Under the IRS COBRA regulations, a health FSA qualifies for the
special limited COBRA obligation only if it satisfies the previous two
conditions (i.e., it is an excepted benefit) and also satisfies the
following third condition:
Condition #3—COBRA Premium Condition. The maximum annual COBRA
premium chargeable for health FSA COBRA coverage must equal or exceed
the maximum annual health FSA coverage amount.

Determining Whether an Account is Overspent
• To determine whether an account is overspent, an employer must
examine the claims activity for a specific qualified beneficiary.
• The determination of whether a qualified beneficiary's account for a plan
year is overspent or underspent as of the date of the qualifying event
depends on three variables:
 The elected annual limit for the qualified beneficiary for the plan year;
 The total reimbursable amount of claims submitted to the health FSA for that plan
year before the date of the qualifying event; and
 The maximum amount that the health FSA is permitted to require to be paid for
COBRA coverage for the remainder of the plan year.
• The “Remaining Annual Limit” is the elected annual limit less the claims
submitted.
• If the remaining annual limit is less than the maximum COBRA premium
that can be charged for the rest of the year, then the account is
overspent.

Who pays first?
• Code §105(h)(6) defines a self-insured medical
reimbursement plan as “a plan of an employer to
reimburse employees for expenses for medical
care for which reimbursement is not provided
under a policy of accident and health insurance.”
• There is one exception, however.
• It seems that the “payer of last resort” principle
still survives as a practical matter when the
employer also has an HRA , unless the HRA
requires the health FSA to pay expenses first.

Who pays first?
• Generally, if an employee participates in both an HRA and a
health FSA offered by the employer and both plans cover the
same expenses, the employee must look first to the HRA for
reimbursement and second (after the HRA limits are exhausted)
to the health FSA.
• However, an HRA plan sponsor may choose, prior to the
beginning of the health FSA plan year, to require in the HRA plan
document that the health FSA will pay first.
• The HRA plan document (and presumably the health FSA plan
document) must clearly specify that the HRA is the payer of last
resort (i.e., that coverage under the HRA is available only after
expenses exceeding the dollar amount of the health FSA have
been paid).

HSA Issues
If an employee’s spouse participates in a
Health FSA during the year and the spouse can
be reimbursed for the employee’s expenses,
will that right make the employee ineligible to
participate in a HSA?
Yes, even if the spouse never submits a claim for
reimbursement the employee’s expenses under
the Health FSA.

HSA Issues
If an employer adopts a HDHP during the year,
may an employee elect to terminate
participation in a Health FSA?
No, a change in cost or coverage is not a
allowable reason to change an election during the
year for Health FSAs.

HSA Issues
Can an employee participate in either a Health FSA or a HRA in
the same month and still be eligible to make or receive
contribution to an HSA?
No, unless the employee’s situation is one of the following:
 The employee’s expenses reimbursed under a Health FSA and/or an HRA
are limited to dental, vision and/or preventive care benefits (“Limited
Purpose Health FSA or HRA”),
 The employee suspends participation in an HRA for the year (“Suspended
HRA”),
 Health FSA or HRA pays expenses above the deductible of the HDHP
(“Post-Deductible Health FSA or HRA”), or
 HRA pays or reimburses the employee’s expenses incurred after the
employee retires (“Retirement HRA”).

HSA Issues
Can an employer amend its general purpose
FSA to a limited purpose Health FSA during the
year?
Yes – unofficial advice from IRS.
An employer may amend its Health FSA to a
limited purpose Health FSA.

Important Changes
Limitation on Health FSA Salary Reductions
 Code § 125(I)(2) imposes a limit on annual salary reduction
contributions to health FSAs offered under cafeteria plans,
effective for plan years beginning in or after 2013.
 The limit was $2,500 for plan years beginning in 2013, and is
indexed for cost-of-living adjustments for subsequent plan
years. ($2,550 for 2015).
 The limit applies on a plan year basis.
 The limit only applies to employee salary reduction
contributions.
 The limit applies separately on an employee basis.
 The limit applies separately for each unrelated employer.

Important Changes
Restrictions on OTC Medicines and Drugs
 Health care reform establishes new restrictions on the
reimbursement of over-the-counter (OTC) medicines and
drugs purchased after December 31, 2010.
 Under these restrictions, health FSAs, can only reimburse
medicines and drugs other than insulin if the medicine or
drug is prescribed (determined without regard to whether a
prescription is necessary to acquire the drug).
 By its terms, the prescription requirement applies only to
medicines and drugs—it does not extend to items other than
medicines or drugs that are available over-the-counter (e.g.,
equipment, supplies, and medical devices).

Health FSAs
• For health FSAs to avoid the requirements of
Health Care Reform, they must meet the
requirements of an “excepted benefit.”
• Free standing health FSAs are still possible if
reimbursing excepted benefits.
• What requirements apply if a Health FSA is not
an excepted benefit?

Health FSAs
A health FSA is considered an excepted benefit if it
satisfies two conditions:
Maximum Benefit Condition: The maximum benefit payable
under the health FSA to any participant in the class for a year
cannot exceed two times the employee's salary reduction
election under the health FSA for the year (or, if greater, the
amount of the employee's salary reduction election for the
health FSA for the year, plus $500), and
Availability Condition: Other non-excepted group health plan
coverage (e.g., major medical coverage) must be made
available for the year to the class of participants by reason of
their employment.

Recent Guidance
• On May 13, 2014, the IRS issued Q&A guidance restating the
conclusion in Notice 2013-54, that an employer is considered to
establish a type of group health plan-called an "employer payment
plan"-if it reimburses employees' premiums for individual health
insurance policies.
• Q/A-1 provides that the employer's exposure to excise taxes of
$36,500 per year (i.e., $100 per day) for each employee affected
by the failures.
• This excise tax liability requires self-reporting on IRS Form 8928.
• Adverse consequences are also possible under ERISA and the
PHSA.
• Q/A-2 indicates that the DOL issued substantially identical
guidance in Technical Release 2013-03, and HHS is expected to
announce soon that it concurs.

Recent Guidance
On February 18, 2015, the IRS released Notice 2015-17 which
provides transition relief from the assessment of excise tax under
Code Section 4980D for failure to satisfy market reforms in certain
circumstances.
The transition relief applies to employer healthcare arrangements
that constitute:
 Employer payment plans, as described in Notice 2013-54, if the plan is
sponsored by an employer that is not an Applicable Large Employer (ALE)
under Code § 4980H(c)(2) and §§54.4980H-1(a)(4) and -2;
 S corporation healthcare arrangements for 2-percent shareholder-
employees;
 Medicare premium reimbursement arrangements; and
 TRICARE-related health reimbursement arrangements (HRAs).

Recent Guidance
• The IRS will not impose excise taxes otherwise
assessable under Code § 4980H for employer
payment plans maintained in 2014 or the first six
months of 2015 (i.e., through June 30, 2015) for
employers that are not “applicable large employers”
(ALEs) for those periods.
• Employers eligible for the relief are also excused from
the requirement to self-report these violations on Form
8928.
• The Notice relief does not apply to stand-alone HRAs
or other arrangements to reimburse any expenses
other than insurance premiums.

Recent Guidance
The Notice also addresses “2% shareholder-employee
healthcare arrangements,” under which a Subchapter S
corporation pays for or reimburses premiums for
individual health insurance coverage for a “2%
shareholder” where the payment or reimbursement is
included in income and the premiums are deductible by
the 2% shareholder-employee under Code § 162(l).
Pending the issuance of additional guidance on these
arrangements, the Notice provides that an S corporation
will not be subject to Code § 4980D or required to file
Form 8928 solely as a result of having a 2%
shareholder-employee health care arrangement.

Recent Guidance
The Notice permits an employer’s reimbursement of Medicare Part
B or Part D premiums to be integrated with another group health
plan offered by the employer, but only if:
 The employer offers a group health plan (other than the premium
reimbursement arrangement) to the employee that does not consist solely
of excepted benefits and offers coverage providing minimum value;
 The employee participating in the premium reimbursement is actually
enrolled in Medicare Parts A and B;
 Premium reimbursement is available only to employees who are enrolled in
Medicare Part A and Part B or Part D; and
 Reimbursement is limited to Medicare Part B or Part D premiums and
premiums for excepted benefits, including Medigap premiums.

Recent Guidance
The Notice confirms that an employer may increase an
employee’s taxable compensation, not conditioned on
the purchase of health coverage, without creating an
employer payment plan (or any group health plan at all).
The Notice reiterates the IRS’s position that an
employer’s payment or reimbursement of employees’
individual health insurance premiums is a group health
plan subject to the market reforms even if the payments
or reimbursements are made on an after-tax basis.

Reimbursed Claim That Should Not Have Been Paid
• The plan administrator should follow the debit card correction
procedures and attempt to correct the error by seeking repayment
from the participant, withholding the improper reimbursement from
the participant's pay, or offsetting the improper reimbursement
against other valid claims under the FSA.
• IRS guidance provides that if the above correction steps have
been unsuccessful, the improper payment should be treated as
any other business indebtedness.
• When this step is applied, the employer must first request
payment consistent with its collection procedures for other
business debts.
• If the payment is not recovered, it should generally be treated as a
forgiven debt and reported as wages on Form W-2 for the year in
which the indebtedness is forgiven; the reported amount is subject
to withholding for income tax, FICA, and FUTA
Error Found Before Year-End

Reimbursed Claim That Should Not Have Been Paid
IRS guidance indicates that under these circumstances,
the mistaken payment should be treated as business
indebtedness which, if forgiven, must be included in
income and reported as wages on Form W-2 (subject to
wage withholding) in the year in which the debt is
forgiven.
The employer can seek repayment of the indebtedness
from the participant on an after-tax basis through
repayment by check or after-tax payroll withholding in the
year in which the error is discovered.
Error Found Before Year-End

Denied Claim That Should Have Been Paid
• If a denied FSA claim is later determined to be eligible
for reimbursement and the run-out period has not
ended, then the participant should be reimbursed for it,
up to the amount available in the participant's account.
• A denied FSA reimbursement claim that should have
been paid is similar to a situation in which an employer
withholds excess cafeteria plan salary reductions.
• In both cases, the employer is contractually obligated
to make the participant whole.
Error Found Before the Run-Out Period Ends

• Upon discovering the error, the employer should
reimburse the participant for the valid claim from
his or her FSA account.
• The claim should be resubmitted if necessary for
plan administration and promptly paid according
to the plan's terms.
• The amount to be paid would be the lesser of the
full amount of the claim or the balance available
in the account for paying valid claims.
Error Found Before the Run-Out Period Ends

• Where claims are paid from general assets, most employers will allow
pre-tax reimbursement of a previously incorrectly denied claim, either
because of formal plan provisions for exceptions to the run-out deadline
or as a practical and equitable correction.
• Some employers correct these errors by reimbursing the claims on a
taxable basis outside the plan.
• To help offset the lost tax benefits, some employers provide a tax gross-
up by increasing the payment for the mistakenly denied claim by the
taxes due on the amount of the payment.
• The amount paid would be the lesser of the full amount of the claim or the
balance that would have been available in the account had the claim
been paid before the funds were forfeited.
• If the reimbursement is grossed up for taxes, it could include the
participant's share of FICA taxes and the amount of federal and state
income taxes payable on the reimbursement amount.
Error Found After the Run-Out Period Ends

Need to Know Issues with Flexible Spending Accounts

More Related Content

Similar to Need to Know Issues with Flexible Spending Accounts (20)

More from benefitexpress (20)

Recently uploaded (20)

Need to Know Issues with Flexible Spending Accounts