Larry Grudzien Attorney at Law

Health Flexible Spending

Account Issues

ABOUT LARRY

Lawrence (Larry) Grudzien, JD, LLM is an attorney practicing

exclusively in the field of employee benefits. He has

experience in dealing with qualified plans, health and

welfare, fringe benefits and executive compensation areas.

He has more than 35 years’ experience in employee benefit

law. Mr. Grudzien was also an adjunct faculty member of

John Marshall Law School’s LL.M. program in Employee

Benefits and at the Valparaiso University’s School of Law.

Mr. Grudzien has a B.A. degree in history and political

science from Indiana University, J.D. degree from Valparaiso

University School of Law and LL.M. degree in tax from

Boston University School of Law. He is a member of Indiana

and Illinois Bars.

AGENDA

• Allowable election changes

• Carryovers

• COBRA

• HRAs & FSAs

• HSAs & FSAs

• Health reform changes –What if repealed?

• Dealing with mistakes

Allowable Election Changes

for Health FSAs

MID-YEAR ELECTION CHANGES

Mid-Year Election Changes

• General irrevocability rule – no change required for the plan year

• Five 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 events

3. Judgments, decrees or orders

4. Entitlement to Medicare or Medicaid

5. FMLA leaves of absence

#1 CHANGE IN STATUS

Note: The plan document must include a provision for each of the above events the employer wishes to allow.

These changes include:

• Change in employee’s marital status

• Change in the number of dependents

• Change in employment status

• Dependents satisfying or ceasing to satisfy dependent eligibility requirements

• Change in residence

• Commencement or termination of adoption proceedings

#1 Change in Status

#1 CHANGE IN STATUS

Change in marital status

includes:

• Marriage

• Divorce

• Death of spouse

• Legal separation

• Annulment

Change in the Number of Dependents

• Birth

• Adoption

• Placement for adoption

• Death

#1 CHANGE IN STATUS

#1 CHANGE IN 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

• 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.

Dependents Satisfying

or Ceasing to Satisfy

Dependent Eligibility

• Attainment of age

• Marriage or any other

similar circumstances

#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

• Under the consistency rule, the change in election is not permissible

unless eligibility for health FSA coverage has changed or, in certain

circumstances, if eligibility for other health coverage has changed

#1 CHANGE IN STATUS

Consistency Requirement

• 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 not previous enrolled and a change in status

occurs this rule will also allow the employee to enroll in order to

enroll the dependents

#1 CHANGE IN STATUS

#2 COBRA Qualifying Event

#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 Judgements, Decrees, Orders

#3 JUDGEMENTS, DECREES, ORDERS

• 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 Entitlements to Medicare

or Medicaid

#4 ENTITLEMENTS 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 Leaves 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

#5 FMLA LEAVES OF ABSENCE

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

Carryover Requirements

• Health FSAs are allowed 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 same 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

• Since offering health FSA carryovers is optional, a plan sponsor 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?

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.

• 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

WHAT IS ALLOWED?

How Do Carryovers Affect HSA Eligibility?

• General-purpose health FSA carryovers raise HSA eligibility issues similar to those presented by health FSA grace periods

• A carryover to a general-purpose health FSA makes the employee ineligible to contribute to his or her HSA for the entire subsequent plan year, even after the carryover is exhausted and even if the employee does not make or receive new health FSA contributions for that plan year

• The adverse effect can be avoided if the plan allows employees to decline or waive their carryovers prior to the beginning of the next plan year – an employee who declines or waives a general-purpose health FSA carryover under the plan's terms may contribute to an HSA during the next plan year if he or she is otherwise HSA-eligible

ADDITIONAL ISSUES RAISED BY CARRYOVERS

Will Carryovers Affect a Health FSA’s Status as an Excepted Benefit?

• Health FSA carryovers are not taken into account when determining

whether a health FSA meets the Maximum Benefit Condition

• However, it is unclear whether carryovers might cause a

health FSA to fail to meet the Availability Condition

ADDITIONAL ISSUES RAISED BY CARRYOVERS

What COBRA Issues Are Presented by Carryover?

• Health FSA carryovers are included when determining the benefit that a

qualified beneficiary is entitled to receive during the remainder of the

plan year in which a qualifying event occurs

• Carryovers must be counted when determining whether an account

is overspent or underspent

• Carryovers are not counted for purposes of determining

the COBRA premium

ADDITIONAL ISSUES RAISED BY CARRYOVERS

Can Employers Limit Carryovers to Employees Who

Elect to Make Salary Reductions in the New Plan Year?

• 2015 guidance clarifies that carryovers can be limited to individuals who

have elected to participate in the health FSA in the next plan year

• This plan design is permitted even if a minimum salary reduction is

required for participation

ADDITIONAL ISSUES RAISED BY CARRYOVERS

Can Employers Limit Carryovers to a Maximum Period?

• 2015 guidance allows health FSAs to

require that carryover amounts be

forfeited if not used within a specified

period of time, such as one year

• This plan design requires additional

administration (e.g., to track the time

limit for each carryover dollar) as well

as ordering rules (e.g., will carryovers

be used first?)

ADDITIONAL ISSUES RAISED BY CARRYOVERS

ADDITIONAL ISSUES RAISED BY CARRYOVERS

Can Employers Establish a Minimum Carryover Amount to Avoid Having to Administer Carryovers of Very Small Amounts?

• Some employers may wish to establish a minimum threshold to

participate in the carryover (e.g., $5 or $10), as is frequently done

for health FSA elections

• The carryover guidance does not indicate whether such a

practice is permitted. However, an IRS official has

informally commented that it would seem

reasonable to have a small minimum

carryover amount, such as $5, $10,

or the minimum annual election

amount for the health FSA

ADDITIONAL ISSUES RAISED BY CARRYOVERS

Are Carryovers Factored Into Non-Discrimination Testing?

• The carryover guidance does not address whether carryover amounts must

be factored into non-discrimination testing (e.g., the 25% key employee

test for cafeteria plans)

• An IRS official has informally commented that carryover amounts would

not be taken into account in nondiscrimination testing for a subsequent

plan year, since these amounts were considered for the year in which the

original contributions were made and would not be taken into account a

second time

COBRA Issues

• 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

DOES COBRA APPLY?

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)

• 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

WHICH HEALTH FSAS QUALIFY?

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

HRAs and FSAsHow They interact?

• 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)

WHO PAYS FIRST?

HSAs: Issues With FSAs

• 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”)

• 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

HSA ISSUES

Health Reform –What Happens If It Is Repealed?

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 ($2,650 for 2018)

• 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

• 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)

IMPORTANT CHANGES

• 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 FSA

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)

• 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

HEALTH FSA

How to Deal With Mistakes?

Reimbursed Claim That Should Not Have Been Paid; Error Found Before Year-End

• 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

Reimbursed Claim That Should Not Have Been Paid;

Error Found After Year-End

• 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

Denied Claim That Should Have Been Paid; Error Found Before the Run-Out Period Ends

• 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

Denied Claim That Should Have Been Paid; Error Found Before the Run-Out Period Ends

• 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

Denied Claim That Should Have Been Paid; 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

Denied Claim That Should Have Been Paid; Error Found After 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

QUESTIONS?

Larry Grudzien, Attorney at Law

• Phone: 708-717-9638

• Email: larry@larrygrudzien.com

• Website: www.larrygrudzien.com

CONTACT INFORMATION