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 will begin to administer the Final and New Proposed Regulations beginning January 1, 2001. ProBusiness is forwarding this information at this time so that you have adequate time to update your enrollment materials by January 1, 2001.

The Final Regulations regarding change in status rules provide (as did the 1997 temporary regulations) 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.

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

Five (5) Change in Status Categories as defined in Final Regulations

The Final Regulations, as contained in Treas. Reg. § 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.
   • Exception to the previous, for purposes of accident or health care coverage, any child to whom section 152(e) applies is treated as a dependent of both parents.
   • 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 a change in work-site.
   • This category has been expanded and now applies to any employment status that affects benefit eligibility.
   • Consolidates the previously free standing (in 1997 Proposed Regulations) category of changes in work schedule into the change in employment status category.
   • Provides a 30-day plus safe harbor for same plan year election changes for certain termination/rehire situations. Generally if employee terminated less than 30 days, would only be able to make new election only if facts and circumstances justify change. Those employees who are terminated for more than 30 days, may make a new election in the plan 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 accountant of attainment of age, student status, or any similar circumstance.
   • This category carried over form 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 election to drop dependent.
   • Employee may add coverage for a dependent who becomes eligible upon beginning 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. Leaving a 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 in section 9801(f) (HIPAA).

• These "Special Enrollment" rights allows the required contributions for such health coverage to be paid on a pre-tax basis.
• Example in the final Regulations clarify 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." Under the Temporary Regulations, only the newly acquired dependent had such rights.
• Final Regulations carve out a narrow exception to the general rule prohibiting retroactive elections under a cafeteria plan. If 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 , ca 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 resulting from a divorce, legal separation, annulment or change in legal custody (including a qualified medical child support order) 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.

• 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 Code §152 dependent, 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 - Under the Final Regulations, Medicare or Medicaid entitlement may allow an employee to make a prospective change election change canceling or reducing health 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

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 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)).

• A uniform rule generally applies to all qualified benefits (accident or health coverage and group term life).
• Special provisions apply for dependent care and adoption assistance benefits and group term life and disability coverage.
• An impact on eligibility is not required for marital status or employment status events to support election changes for group term life or long term disability coverage.

Threshold Question = Has the change in status affected coverage eligibility of the employee, spouse or dependent for the qualified benefit?

Two Part Consistency Test

Part One - 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, requested change must be on account of and corresponds with a change in status that result in the employee, spouse or dependent gaining or losing eligibility for coverage under an employer's plan.

Part Two - Has the specific consistency requirement been satisfied?

• The Final Regulations set forth two specific consistency tests. One when dependent eligibility is lost and another when coverage eligibility is gained through another employer.

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

Consistency Rule for Gain of Coverage Eligibility Under Another Employer Plan - If an employee, spouse or dependent gains eligibility for coverage under another employer's cafeteria plan, as a result of marital status or change in employment status, an employee's election under the cafeteria plan to cease or decrease coverage for that individual under the cafeteria plan corresponds with that change in status only if coverage for that individual becomes effective or is increased under the other employer's plan.

Special Consistency Rule for Life or Disability Coverage - If the change in status is a change in the employee's marital status or change in employment status of the employee's spouse or dependents, an election to increase or an election to decrease, group term life or disability income coverage must correspond with that change in status. This can occur even if the requested change does not track the increase or decrease in family size, or result in the gain or loss of eligibility.

The Proposed Regulations, as contained in Prop. Treas. Reg. § 1.125 -4, were as the Final Regulations, released by the IRS on March 23, 2000 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 in regards to status changes:

• Add a sixth change in status category entitled "Adoption Assistance"
• Extends the change in status rules to apply to Dependent Care Assistance Programs (DCAP) and Adoption Assistance Plans
• Address specific consistency issues for dependent care and adoption assistance benefits
• Significantly expand the scope of the change in cost or coverage provisions originally in the 1989 proposed regulations
• "Spousal Election Lock" rule eliminated

Sixth (6) Status Change by Proposed Regulations

Adoption Assistance - A new, sixth in status category is added by the Proposed Regulations. It provides that commencement or termination of adoption proceedings will allow an election change under an adoption assistance program.

Change in Status Rules To Apply to DCAP's

The Proposed Regulations have extended the change in status rules to apply to DCAP's and adoption assistance plans. Consequently, there will be only one set of status changes rather than the previous two; the "status changes" used for Health FSA's (1997 Proposed Regulations) and the "family status changes" (1989 Proposed Regulations) utilized for Dependent Care Assistance Programs.

Consistency Requirement

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; 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 for the tax exclusions available under Code § 129 or 137. For example, a dependent child's turning age 13 would affect eligibility for dependent care expenses

• 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 DCAP. This is a reversal from prior informal IRS guidance.

Proposed Regulations on Changes in Cost or Coverage

The March 1989 regulations allowed for a change in employee elections of there was a change in cost or coverage, but limited application of this rule to health plan coverage provided by an "independent, third-party provider". The IRS interpreted this rule narrowly limiting its application to insured indemnity and HMO arrangements. And 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 expanded to DCAP's as well.

Changes in Cost - The Proposed Regulations provide that a plan can require an automatic election increase that corresponds to an increase or decrease in the cost of coverage. Moreover, if there is a significant cost increase (not defined by IRS), a plan may allow participants to either make a prospective increase (or decrease) in affected employees' elective contributions for the plan.

Automatic Increase for "Small" Cost Changes - If the cost of a qualified benefits plan increases (or decreases) during a period of coverage and, under the terms of the plan, employees are required to make a corresponding change in their payments, the cafeteria plan may, on a reasonable and consistent basis, automatically make a prospective increase (or decrease) in affected employees' elective contributions for the plan.

Election of Alternative Coverage if "Significant" Cost Increase - If the cost of a benefit significantly increases during a period of coverage, the cafeteria plan may permit employees to either make a corresponding prospective increase in their payments, or to revoke their elections and, in lieu thereof, to receive on a prospective basis coverage under another benefit package option providing similar coverage.

• To drop an existing election MUST elect coverage under a similar benefit option
• No guidance is offered as to what is considered similar
• No guidance is given as to what is "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, 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 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 coverage, the cafeteria plan may permit affected employees to revoke their elections under the plan and make a new election for coverage under another benefit package option providing similar coverage.

• It is unclear what is meant by "significantly curtailed"
• Proposed Regulations provide 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
• No guidance is provided as to what issues should be considered in determining whether coverage is "similar"

Addition (or elimination) of Benefit Package Option - If during a period of coverage a plan adds a new coverage option (or eliminates an existing option) the cafeteria plan may permit affected employees to elect the newly-added option (or elect another option if an option has been eliminated) prospectively on a pre-tax basis and make corresponding election changes with respect to other benefit option providing similar coverage.

• Application of this rule should enable employees to opt out of their election of employer coverage options (at will) whenever a new coverage option becomes (or ceases to be) available under a plan
• The new Proposed Regulations permit employees to change their election to take a newly available option of the same type of benefit
• Not clear as to whether this rules applies to employees who previously waived coverage

Dependent Care Coverage Changes - Examples in the Proposed Regulations demonstrate how broad the coverage may be interpreted. In one example, the regulations conclude that an employee's change in day care provider by choice is a "significant change in coverage similar to a benefit package option becoming available" that would therefore allow an election change.

• Change in day car provider as a result of employee choice would qualify for election change
• If dependent turns 13, change in election is allowed
• If dependent enrolls in school (decreasing need for DCAP) election change is allowed

Change in Coverage of Spouse under their Employer's Plan "Election Lock" Is Eliminated - A cafeteria plan may permit 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
• Plan permits participants to make an election for a period of coverage that is different from the period of coverage under the cafeteria plan or qualified benefits plan of the spouse's, former spouse's, or dependent's employer
• Consistency requirement must be satisfied
• New Proposed Regulations confirm that an employee is able to make a corresponding election change when coverage is elected under a spouse's plan during open enrollment

This rule can apply to four (4) different types of coverage changes:

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
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. On the other hand, it is significant to note that the Final and Proposed Regulations specifically provide that benefit elections (other than HIPAA enrollments), must be made prospectively-i.e., the Final Change in Status Regulations refer to election changes for the "remaining period" of coverage and the Proposed Cost or Coverage Regulations specifically refer to "prospective" election changes.

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.)

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