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Employers May Extend Time for Employee Reimbursements from Flexible Spending Accounts
By Jeni L. Lassell
[September 2005]
Under a recent IRS notice, unused contributions from the immediately preceding plan year to a flexible spending account under a cafeteria plan may be used to reimburse participants for eligible expenses (e.g., health care or dependent care expenses) incurred during a 2½ month grace period after the end of the year. This notice modifies the IRS's previous position requiring that plan participants forfeit any remaining balance at the end of each plan year.
If an employer timely amends its cafeteria plan to implement this new grace period, the participant may have as long as 14 months and 15 days (the 12 months in the current cafeteria plan year plus the grace period) to use contributions for a plan year before forfeiting those amounts. For example, any eligible expenses incurred within the first 2½ months of the 2006 plan year may be paid from any remaining balance from 2005. Once that amount is exhausted, the participant would be reimbursed using his or her 2006 contributions. Furthermore, the plan may still provide for a “run-out period” after the grace period, during which expenses incurred during the plan year and the grace period may be submitted to the plan. The grace period must apply to all participants in the cafeteria plan.
Employers must act quickly to amend plans before year-end
This new rule will apply to the current plan year only if employers amend the cafeteria plan document before the end of the year to provide for the grace period. Accordingly, a cafeteria plan with a January through December plan year must be amended by Dec. 31, 2005 in order for participants to be permitted to use any remaining 2005 balance before March 15, 2006. Ideally plans would be amended before the upcoming open enrollment period so that the grace period can be explained to employees at the same time.
Employers should consider consequences before adopting the new grace period
Before amending a cafeteria plan to provide for the grace period, employers should consider the impact on plan compliance and administration. For example:
Plan Administration. Plan sponsors need to be able to accurately track expenses incurred and reimbursed from one plan year to the next for bookkeeping purposes. The addition of the grace period will complicate this tracking system. The plan sponsor needs to decide whether expenses incurred in the grace period will always be paid from the 2005 balance first, or whether to let the employee designate whether to use the 2005 balance or 2006 coverage. They also need to decide how long of an additional run-out period will be allowed after the grace period ends.
Dependent Care Assistance Programs. The IRS requires any dependent care expenses incurred during the grace period to be counted against the dependent care limit under the Code for the new plan year. The IRS has yet to provide guidance on how employees participating in a plan with the grace period will report the total amount of dependent care benefits received during a year on Form 2441. The IRS has issued guidance for employers that guarantees they may continue to estimate the amount of reimbursement for dependent care expenses by using the amount of an employee’s salary reductions for the year under the cafeteria plan (plus any employer matching contributions). This estimate may be reported on the Form W-2, if the actual amount is unknown at the time it is prepared. For example, if a participant elects to defer $5,000 in a DCAP for 2005, the employer can report that amount on the 2005 W-2 due by Jan. 31, even though the grace period is not closed so the actual amount used in 2005 is not known.
Cost. Currently, employers may use plan forfeitures to offset certain plan costs, including the costs of subsidizing those participants who terminate employment mid-plan year after spending more on qualified benefits than they contributed into the cafeteria plan prior to termination. Providing a grace period will lead to decreased forfeitures available to offset these plan expenses.
Health Savings Accounts. Providing the grace period may disqualify an individual from participation in a health savings account for that new plan year, if the employee wanted to switch from participating in a health FSA to an HSA.
Although the grace period provides employees with greater flexibility, plan sponsors should carefully consider the possible costs and administrative headaches before amending their plans to adopt the grace period. A grace period may just delay the inevitable last minute rush to spend contributions for employees, while increasing the complexity of plan administration for the employer.
IRS LINK:
IRS Notice 2005-42
For more information, please contact:
Other DWT Contacts:
Jeff Belfiglio, Bellevue, (425) 646-6128, JeffBelfiglio@dwt.com
Marissa A. Olsen, Seattle, (206) 628-7714, MarissaOlsen@dwt.com
This
Advisory is a publication of the Employer Services Department of Davis Wright Tremaine LLP.
Our purpose in publishing this Advisory is to inform our clients
and friends of recent developments in employment
law. It is not intended, nor should it be used, as a substitute
for specific legal advice as legal counsel may be given only
in response to inquiries regarding particular situations.
Copyright
© 2005, Davis Wright Tremaine LLP.
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