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New Cafeteria Plan Regulations - 1.125-2 The second set of Internal Revenue Code (IRC) Section 125 regulations are all about making and revoking elections in a cafeteria plan. The good news? This is the shortest of the five new regulations published by the Internal Revenue Service (IRS) last August. 1.125-2 – Rules on making and revoking elections in a cafeteria plan. In general, a plan is not a cafeteria plan unless it provides, in writing, that employees are permitted to make elections among permitted taxable benefits and qualified non-taxable benefits offered through the plan. All elections must be irrevocable and cannot be modified except for the acceptable election changes as outlined in the IRS 1.125-4 Regulations. First of all, elections must be made before the earlier of:
A benefit is "currently available" if it has been paid to the employee or if the employee is able to receive the cash or other taxable benefit at the employee’s discretion. Employers who allow participants to change their elections for no reason and receive the unused amount as cash have violated this regulation. The cafeteria plan fails to be a cafeteria plan and all employees are treated as having received their benefits as taxable – even if they didn’t revoke their elections. What this all comes down to is that participants may not make retroactive elections. Once compensation is earned and/or received, the period of time to convert some or all of their earned income to a nontaxable benefit is over. The cash has already been paid to the employee. That is why it is so important to make sure that enrollment is completed before the beginning of a new plan year. After the plan year starts, taxable compensation has already been earned and/or received. If timely elections are not received by the plan, the employee will have to wait until the next enrollment period or experience a change in status to enter the plan. Secondly, if an employee experiences a change in status, the change must be made on a prospective basis. The only time a retroactive election is allowed is under the special enrollment rights of HIPAA. The HIPAA event of birth, adoption, or placement for adoption allows an employee to change their election within 30 days of the event and go back to cover eligible expenses incurred during those 30 days. One more point about elections. The IRS makes an allowance for electronic elections. The enrollments may be completed and retained electronically and are not required to be written paper documents. 2. Automatic elections. New employees or current employees who fail to timely elect into the cafeteria plan may be placed into the plan via a "default" or automatic election. One example of an automatic election is where the plan document states that a current participant in the plan would continue their same election from a prior plan year into each succeeding plan year. These are sometimes called evergreen elections. Normally, evergreen elections are used for the premium only portion of the cafeteria plan. This is so the plan administrator does not have to have everyone sign up for the insurance premium portion of the plan every year. Basically – the participant will pay their portion of the health insurance through the cafeteria plan unless they make a timely decision to revoke their election. Another example of an automatic election would be for new employees. Let’s say that an employer offers health insurance coverage and requires employees pay their share of the premium through the cafeteria plan. If a timely election is not received by the plan prior to the conclusion of open enrollment, the employee is deemed to have made the default election. This default election could enroll the employee in single health insurance coverage, with their portion of the premium paid on a pre-tax basis through the cafeteria plan. In order to invoke automatic or default elections, the plan sponsor must provide a notice to all new and current employees. The notice must contain:
3. Election rules for contributions made to a Health Savings Account (HSA). Elections and changes in salary redirections to an HSA are allowed through a cafeteria plan. These HSA contributions may only be made with non-taxable salary redirection and may be modified on a prospective basis. At any time during the plan year, a participant may change their salary redirection amount to their HSA or discontinue their salary redirection. No change in status is required. In order to allow for HSA contributions, the plan must:
4. Optional election for new employees. A cafeteria plan may allow newly-hired employees a 30-day election period, and have the election effective as of the employee’s hire date. Two things need to happen here. First, the plan must state eligibility for benefits in the cafeteria plan starts on an employee’s first day of employment. After that, the plan can accept contributions from salary redirection that has not yet been earned. Employees who terminate employment and are rehired within 30 days are not eligible for this new 30-day election period. Nor does this apply to current employees who don’t get elections turned in on time for new-year enrollment. Stay tuned. This series of articles will continue with the details of IRS 1.125-5 set of regulations.
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