This entire issue is dedicated to the Flexible Spending Account (FSA) Final Regulations and the New Proposed Regulations which pertain to Status Changes. These were issued by the Internal Revenue Service (IRS) on March 23, 2000. ProBusiness Administrative Services (ProBusiness) will begin to administer the Final and New Proposed Regulations beginning January 1, 2001. ProBusiness is forwarding this information now so that you have adequate time to update your enrollment materials for your January 1, 2001 open enrollment.

Not unlike the 1997 temporary regulations, the final regulations regarding change in status rules provide a two-step analysis in determining whether or not an employee may make a mid-year election change:

1. A change in status event must have occurred.
2. The participant's requested change must be consistent with the event (see pages 3 and 5 for more detail on consistency).

Note: Code Section 125 does not require a cafeteria plan to permit election changes.

Five Change in Status Categories as defined in Final Regulations

The final Treasury Regulations (§ 1.125-4), provide that events falling within the following five categories qualify as change in status events:

1. Change in employee's legal marital status - Including marriage, divorce, death of spouse, legal separation, and annulment.
   • No changes from temporary regulations.
2. Change in number of dependents - Including birth, adoption, placement for adoption, and death.
   • Dependent is formally defined as a tax dependent under Code §152,
   • This rule disallows election changes for non-tax dependents, including parents, domestic partners, and children of domestic partners.
3. Change in employment status - Any of the following events that change the employment status of the employee, the employee's spouse, or the employee's dependent: a termination or commencement of employment; a strike or lockout; a commencement of or a return from an unpaid leave of absence; and/or a change in work-site.
   • This category has been expanded and now applies to any employment status that affects benefit eligibility,
   • Consolidates the previous category of changes in work schedule into the change in employment status category,
   • Provides a 30-day safe harbor for same plan year election changes for certain termination/rehire situations. Generally if an employee terminated less than 30 days before re-hire, that employee would be able to make a new election upon re-hire only if facts and circumstances justify the change. Those employees who terminated more than 30 days before re-hire may make a new election in the plan after re-hire with no strings attached.
4. Dependent satisfies or ceases to satisfy eligibility requirements - Events that cause an employee's dependent to satisfy or cease to satisfy eligibility requirements for coverage on account of attainment of a certain age, student status, or any similar circumstance.
   • This category carried over from temporary regulations,
   • If a dependent becomes ineligible for coverage due to the attainment of a certain age, marriage or loss of student status, then the employee may change the election to drop a dependent,
   • Employee may add coverage for a dependent who becomes eligible upon starting school.
5. Residence change - A change in the place of residence of the employee, spouse, or dependent.
   • Final regulations moved work-site changes into the "Employment Status" category which leaves residence change as its own category,
   • If a participant moves in or out of the territory of an HMO, an election change based on the residence change may be permitted. Note: The residence change must affect the employee's eligibility for coverage,
   • In a reversal from the temporary regulations, the final regulations clarify that substitute coverage must be selected (if available).

Other Events in the Final Regulations Permitting Mid-Year Election Changes

HIPAA Special Enrollment Rights - The final regulations confirm that an employee enrolled in a cafeteria plan generally may revoke an election for coverage under a group health plan during a period of coverage and make a new election that "corresponds" with the special enrollment rights provided under HIPAA.

• These "Special Enrollment" rights allow the required contributions for such health coverage to be paid on a pre-tax basis,
• Example in the final regulations clarifies that if an employee, spouse or dependent is entitled under HIPAA to enroll in a group health plan, "a cafeteria plan may permit the employee to elect to enroll pre-existing dependents in the underlying group health plan." The IRS refers to this as the "tag-along" rule. Under the temporary regulations, only the newly acquired dependent had such rights,
• Final regulations allow one situation where retroactive elections may be used under a cafeteria plan. If a newly acquired dependent is enrolled within the HIPAA special enrollment period (minimum of 30 days from birth or adoption), child's coverage must be retroactive to date of birth, adoption or placement for adoption. The cafeteria plan may permit the employee to change their salary reduction election, for future pay periods, to pay the extra cost of the child's coverage retroactive to the date of birth or adoption,

Note: Most health FSA's are excepted benefits under HIPAA and therefore the special requirements (including retroactive enrollments) would not apply to such coverage.

COBRA Elections - In the event that the employee or dependent becomes eligible for continuation coverage under the group health plan of the employee's employer, the cafeteria plan may permit the employee to elect to increase payments under the employer's cafeteria plan in order to pay for the continuation coverage.

Note: The COBRA rule does not apply to pre-tax contributions for COBRA coverage under another employer's plan.

Judgment, Decree, or Order - If there is a judgment, decree, or order due to a divorce, legal separation, annulment or change in legal custody that requires accident or health coverage for an employee's child or foster child, a cafeteria plan may permit the employee to change their election to add or drop coverage consistent with that order. This also would be true in the case of a qualified medical child support order.

• Final regulations clarify that the change in election to add coverage (under the cafeteria plan) may apply to any dependent meeting Code §152 definitions,
• If the child is not the employee's dependent as defined by §152, the health plan must still comply with the order, but the employee will need to pay for the added coverage outside the cafeteria plan on an after tax basis.

Entitlement to Medicare or Medicaid - Medicare or Medicaid entitlement, under the final regulations, may allow an employee to make a prospective election change which cancels or reduces health care coverage under the employer's plan and to adjust their salary reduction amounts accordingly. Also if an employee, spouse or dependent is no longer entitled to Medicare or Medicaid, the cafeteria plan may permit the employee to make a prospective election to commence or increase coverage of that employee, spouse, or dependent under the accident and health plan.

The Consistency Requirement - Accident, Health, and Group Term Life Coverage

There is a general consistency rule and three specific consistency rules to be applied according to the specific fact scenario.

General Consistency Rule - An election change satisfies the requirements with respect to accident or health coverage or group-term life insurance "only if the election change is on account of and corresponds with a change in status that affects eligibility for coverage under an employer's plan" (Treas. Reg. § 1.125-4 (3)).

To Meet The General Consistency Rule Ask:

Is the requested change on account of and does it correspond with a change in status that affects eligibility for coverage under an employer plan?

• In order to be consistent, the employee, spouse or dependent must gain or lose eligibility for coverage under an employer's plan.

Three Specific Consistency Rules:

1. Consistency Rule for Loss of Dependent Eligibility - In the event of the following status changes, the employee can only cancel accident or health insurance coverage for the spouse or dependent, as applicable:
   • Divorce
   • Annulment
   • Legal Separation
   • Death of spouse or dependent
   • Dependent ceasing to satisfy the eligibility requirements for coverage
     
     
2. Consistency Rule for Gaining Coverage Eligibility Under Another Employer Plan - Should an employee, spouse or dependent become eligible for coverage under another employers' plan as a result of a change in marital or employment status, the decision to cease or decrease coverage for the employee, spouse or dependent under the current plan would be considered to be consistent (and thus valid) only if the employee, spouse or dependent actually elects or increases the coverage under the other employer's plan.
   
   
3. Consistency Rule for Life or Disability Coverage - In the event of a change in the employee's marital status or a change of employment status of the employee's spouse or dependent, an election to change the coverage levels of either the group term life or disability income coverage would only be considered consistent (and thus valid) if the change in the levels is consistent with the event. However, the change can be considered consistent regardless of whether the family size increases or decreases or regardless of whether the employee, spouse or dependent gains or loses eligibility for group term life or disability coverage.

Proposed Treasury Regulations (§1.125-4), are effective for plan years beginning on or after January 1, 2001 and will amend the Final Regulations. ProBusiness will begin to administer the proposed regulations in conjunction with plan years effective January 1, 2001 and thereafter. The proposed regulations address the following issues regarding status changes:

• Addition of a sixth change in status category entitled "Adoption Assistance,"
• Extending the change in status rules to apply to Dependent Care Spending Accounts (DCSA) and adoption assistance plans and address specific consistency issues for dependent care and adoption assistance benefits,
• Significantly expanding the scope of the change in cost or coverage provisions originally set out in the 1989 proposed regulations and,
• Elimination of the spousal "Election Lock" rule.

Sixth Status Change Set Out by Proposed Regulations

Adoption Assistance - The proposed regulations add a new and sixth status category, which states that the commencement or termination of adoption proceedings will allow an election change under an adoption assistance program sponsored by the employer.

Change in Status Rules To Apply to DCSAs

The proposed regulations have extended the change in status rules to apply to DCSAs and adoption assistance plans. Consequently, there will be only one set of status changes rather than the previous two ("status changes" used for Health FSA's under the 1997 proposed regulations and "family status changes" used for DCSAs under the 1989 proposed regulations).

The Consistency Requirement - DCSA's and Adoption Assistance Plans

Consistency Rule - The proposed regulations address specific consistency issues for dependent care and adoption assistance benefits and provide that the consistency rule is satisfied for dependent care and adoption assistance benefits if either:

1. The election change is on account of and corresponds with a change in status that affects eligibility for coverage under an employer's plan as set out in the accident, health, and group term life coverage consistency requirement addressed on page 3; or
2. The election change is on account of and corresponds with a change in status that affects eligibility of dependent care or adoption expenses specifically. By example, the proposed regulations clarify that a dependent care assistance election may be cancelled where a dependent child turns age 13 in the middle of the plan year and is no longer a qualifying individual under the DCSA. This is a reversal from prior informal IRS guidance.

Proposed Regulations on Changes in Cost or Coverage

Although the March 1989 regulations allowed for a change in employee elections if there was a modification in cost or coverage, such a change was only allowed if the health plan coverage was provided by an "independent, third-party provider". The IRS interpreted this rule narrowly limiting its application to insured indemnity and HMO arrangements. Therefore sponsors of self-funded plans were prohibited from passing on mid-year cost increases.

• Now, self-funded plans, other than health FSA's, can utilize the cost change rules.
• Cost or coverage rules are now expanded to DCSAs as well.

Changes in Cost - The proposed regulations allow a plan to require an automatic election increase or decrease that corresponds to an increase or decrease in the cost of coverage. Moreover, if there is a significant cost increase, a plan may allow participants to increase their election or change their election. No change in the health FSA election is allowed due to a change in cost.

Automatic Increase for "Small" Cost Changes - If the cost of the coverage increases or decreases during the plan year and the plan requires employees to make a corresponding change in their premium payments, the cafeteria plan may automatically make a prospective increase or decrease to the affected employees' elective contributions for the plan, as long as this is done on a reasonable and consistent basis.

Election of Alternative Coverage if "Significant" Cost Increase - If the cost of the coverage significantly increases during a period of coverage, the cafeteria plan may allow employees to make a corresponding prospective increase in their premium payments, or to revoke their elections and instead receive other similar coverage on a prospective basis.

• To drop an existing election an employee MUST elect coverage under a similar benefit option, unless no other coverage alternative is available.
• No guidance is offered as to what is considered to be a similar benefit option,
• No guidance is given as to what is considered a "significant" increase in cost.

Special Rule for Dependent Care - If a dependent care provider increases the monthly fee, the participant can increase their salary reduction election accordingly to reflect the new fee.

• Exception: If care-giver is a relative as defined in Code §152, an increase in cost WILL NOT be considered a status change.

Changes in Coverage - The new proposed regulations include the prior rule allowing an election of alternative coverage if there is a significant curtailment in coverage. In addition, a new rule allows for election changes in the event a newly added OPTION is made available or an existing benefit is eliminated.

• As with the change in cost rule, no change to the health FSA election is allowed due to a change in coverage

Significant Curtailment - If the coverage under a plan is significantly curtailed or ceases during a period of coverage, the cafeteria plan may permit affected employees to revoke their elections under the plan and make a new election for coverage under another coverage option providing similar benefits.

• The proposed regulations note that coverage is significantly curtailed "only if there is an overall reduction in coverage provided to participants under the plan so as to constitute reduced coverage to participants generally,"
• In order to drop an election, participants MUST elect coverage under a similar benefit option, unless no other coverage alternative is available.

Addition or Elimination of a Plan Benefit - If during a period of coverage, a plan adds a new benefit (or eliminates an existing benefit) the cafeteria plan may permit affected employees to elect the new benefit (or elect another benefit if a benefit has been eliminated) prospectively on a pre-tax basis and make corresponding election changes with respect to other benefits providing similar coverage. Again, no changes can be made to a health FSA election based on this change.

• This rule will allow employees to opt out of their election of employer coverage options whenever a new coverage option becomes available or ceases to be available under a plan,
• The proposed regulations allow employees to alter their elections to take a newly available coverage option of the same type of benefit.

Dependent Care Coverage Changes - Examples in the proposed regulations allow for broad dependent care coverage changes.

• Change in daycare provider as a result of employee choice would qualify for election change,
• If dependent turns 13 during the plan year, a change in election is allowable,
• If dependent enrolls in school during the plan year (decreasing need for DCSA), the election change is allowed.

Change in Coverage of Spouse under his or her Employer's Plan

"Election Lock" Is Eliminated - A cafeteria plan may allow an employee to make a prospective election change that is on account of and corresponds with a change made under the plan of the spouse's, former spouse's or dependent's employer if:

• Plan permits participants to make an election change that would be permitted under the proposed or final regulations,
• Consistency requirement is satisfied.

There are four types of coverage changes where this rule applies:

1. Mandatory changes in coverage initiated by the insurer of the spouse's plan,
2. Mandatory changes in coverage initiated by a spouse's employer,
3. Optional coverage changes in coverage initiated by a spouse's employer, or
4. Changes in coverage initiated by the participant's spouse through open enrollment at the participant's place of employment.

NOTE:

The final regulations acknowledge that retroactive elections are permissible where they correspond to a HIPAA special enrollment. It is significant to note, however, that the final and proposed regulations specifically provide that benefit elections (other than HIPAA enrollments), must be made prospectively-i.e., for the "remaining period" of coverage.

The preceding information is only a summary of the regulations released by the IRS on March 23, 2000. You should review the full body of the regulations to determine how they apply to your specific fact scenarios.

Please contact ProBusiness for further information at:
20000 North Creek Parkway, Suite 200, Bothell, WA 98011
Phone: (425) 415-4000 Fax: (425) 417-4795
e-mail: bsa@probusiness.com

(ProBusiness does not make any representation or warranty that the information contained in this newsletter, when used in a specific and actual situation, meets applicable legal requirements. This newsletter should not be construed as legal advice. Your legal counsel should be consulted on all specific fact situations.)

Go to page top