Health Flexible Spending Account Issues

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1 Health Flexible Spending Account Issues Larry Grudzien Attorney at Law

2 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.

3 AGENDA Allowable election changes Carryovers COBRA HRAs & FSAs HSAs & FSAs Health reform changes What if repealed? Dealing with mistakes

4 Allowable Election Changes for Health FSAs

5 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

6 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

7 #1 CHANGE IN STATUS 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 Note: The plan document must include a provision for each of the above events the employer wishes to allow.

8 #1 Change in Status

9 #1 CHANGE IN STATUS Change in marital status includes: Marriage Divorce Death of spouse Legal separation Annulment

10 #1 CHANGE IN STATUS Change in the Number of Dependents Birth Adoption Placement for adoption Death

11 #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.

12 #1 CHANGE IN STATUS Dependents Satisfying or Ceasing to Satisfy Dependent Eligibility Attainment of age Marriage or any other similar circumstances

13 #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

14 #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

15 #2 COBRA Qualifying Event

16 #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.

17 #3 Judgements, Decrees, Orders

18 #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.

19 #4 Entitlements to Medicare or Medicaid

20 #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

21 #5 FMLA Leaves of Absence

22 #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

23 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

24 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

25 Carryover Requirements

26 WHAT IS ALLOWED? 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

27 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

28 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.

29 WHAT IS ALLOWED? 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

30 ADDITIONAL ISSUES RAISED BY CARRYOVERS 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

31 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

32 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

33 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

34 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?)

35 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

36 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

37 COBRA Issues

38 DOES COBRA APPLY? 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

39 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)

40 WHICH HEALTH FSAS QUALIFY? 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

41 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

42 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

43 HRAs and FSAs How They interact?

44 WHO PAYS FIRST? 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

45 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)

46 HSAs: Issues With FSAs

47 HSA ISSUES 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

48 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 )

49 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

50 Health Reform What Happens If It Is Repealed?

51 IMPORTANT CHANGES 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

52 Restrictions on OTC Medicines and Drugs IMPORTANT CHANGES 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)

53 HEALTH FSA 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?

54 A health FSA is considered an excepted benefit if it satisfies two conditions: HEALTH FSA 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

55 How to Deal With Mistakes?

56 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

57 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

58 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

59 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

60 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

61 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

62 QUESTIONS?

63 CONTACT INFORMATION Larry Grudzien, Attorney at Law Phone: Website: