By: HUB’s EB Compliance Team
It has been 44 years this month, since Section 125 was added to the Internal Revenue Code which allowed for “cafeteria plans.” Since that time, employees have enjoyed the tax savings and extra take-home pay they receive because premiums of certain benefits are paid with pre-tax wages. Employers also like cafeteria plans because, in addition to having happier employees, they also save on taxes as well.
Importantly, cafeteria plans cannot be established solely for the purpose of tax savings; Congress and the IRS do not give away tax revenues without restrictions. To continue to enjoy this benefit, the IRS requires that all cafeteria plans meet certain requirements including having a written plan document, making the pre-tax benefit available without discrimination, and ensuring participant elections are generally irrevocable for 12-months. If these and other requirements are not met, the pre-tax benefit of a cafeteria plan are lost, which would result in the employees and employer having an employment tax obligation due.
Overview of Cafeteria Plan Irrevocability Rules
Cafeteria plans must follow the general principle that participant elections cannot be changed for the period of coverage (generally, the plan year). There are limited exceptions and, for the most part, employers can choose whether or not to offer certain midyear election changes. However, the permissible midyear election change opportunities must be included in the cafeteria plan document. These include a change in job status (of the employee or the employee’s spouse or dependents), certain cost changes to the underlying benefit plan, and other limited events.
Plan sponsors must, however, allow participants qualifying for a HIPAA special enrollment right under a group health plan to make certain health coverage changes. For example, if an employee experiences a change in life status (e.g., marriage, birth, adoption of a child), they may make a midyear election change that is consistent with the life change.
In addition, if HSAs are offered through a cafeteria plan, election changes must be allowed at least monthly. This is designed to match up with the HSA monthly eligibility rules. The IRS has indicated that the list of permitted cafeteria plan election change events is exhaustive. In other words, employers cannot make or allow additional election changes beyond those in the cafeteria plan rules
Once the Plan Year Starts
Notably, there is not a permitted opportunity to change elections within the month after the start of the plan year. Some employers incorrectly believe that employees have 30 or 31 days after the start of the plan year to change their elections. This is not the case.
In addition to violating the cafeteria plan rules, it may also violate the rules of applicable insurance policies with the carriers. Many group medical, dental, and vision policies incorporate the cafeteria plan change in status rules, even if the employer is not charging employees for the coverage or is requiring them to pay on an after-tax basis.
How to Ensure Elections Are Accurate
There are some steps employers can take to ensure the accuracy of employee elections.
First, educate employees during open enrollment and advise them to give serious consideration to what elections they make before submitting their enrollment choices. This could include statements that elections can generally only be changed due to changes in status provided in the plan document.
Second, if possible, provide employees with written confirmation of their elections after the close of each open enrollment period and before the new plan year begins. Employees should be instructed in writing to review their elections and advise the employer of any corrections that may be needed before the plan year begins. The cafeteria plan rules are fairly flexible on changing elections before the plan year starts.
But What About Mistakes?
Even with the best process for verifying elections, employees may still make mistakes. Although the permitted election change regulations do not address mistakes, IRS officials have in the past reportedly commented informally that an election may be corrected but only if there is clear and convincing evidence that a mistake has been made—e.g., an employee has made a Dependent Care Flexible Spending Account/DCAP election (rather than a health FSA election) when there are no eligible dependents.
While there are no hard and fast rules, employers should consider requiring employees who claim they made a mistake to provide a sworn statement as to the nature of the mistake and intended election. If there is clear and convincing evidence that an individual has made a mistake in an election then the election can be undone, even retroactively, to correct the mistake.
In addition, IRS officials have reportedly said informally that an employer administration or clerical mistake in recording an election can be undone, again only if there is clear and convincing evidence that it was an employer error. This would include mistakes attributable to data entry, data processing, or other employer administrative errors. Such corrections may also be retroactive.
The argument in both cases is that no real change is involved—the election was invalid from the start. That is why clear and convincing evidence (which is a very high standard) is required.
Importantly, these are informal, non-binding statements of IRS officials. As a result, employers cannot rely on them and an IRS agent in an audit may not accept them. Employers considering allowing election changes based on these mistakes should consult with experienced benefits counsel and should allow these changes only sparingly.
To help reinforce the truthfulness of the employee’s claim, employers may impose other conditions, such as establishing a time limit (e.g., 30 days) after the beginning of the plan year or close of the first payroll period when mistakes must be brought to the employer's attention; requiring confidentiality from the employee as to the mistake and correction (to the extent permitted by law); and imposing a ban on future corrections by the same employee for a period of time (e.g., three plan years). Notably, these are examples and not hard and fast rules given that no cafeteria plan rule allows for changes based on mistakes.
Takeaways
Employers should be mindful that once the plan year starts, the ability to change elections is limited. To help ensure elections are accurate, plan sponsors can:
- Educate employees during open enrollment.
- Ask employees to verify their elections before the plan year starts.
Such measures may help avoid the need to move into the gray area of correcting mistakes. Importantly, simply allowing individuals to make any changes they want within the first 30 or 31 days after the start of the plan year is not permitted.
If you have any questions, please contact your HUB Advisor. View more compliance articles in our Compliance Directory.
NOTICE OF DISCLAIMER
Neither Hub International Limited nor any of its affiliated companies is a law or accounting firm, and therefore they cannot provide legal or tax advice. The information herein is provided for general information only and is not intended to constitute legal or tax advice as to an organization’s or individual's specific circumstances. It is based on Hub International's understanding of the law as it exists on the date of this publication. Subsequent developments may result in this information becoming outdated or incorrect and Hub International does not have an obligation to update this information. You should consult an attorney, accountant, or other legal or tax professional regarding the application of the general information provided here to your organization’s specific situation in light of your or your organization’s particular needs.