[Federal Register Volume 65, Number 57 (Thursday, March 23, 2000)]
[Rules and Regulations]
[Pages 15548-15553]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-5817]
[[Page 15548]]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[TD 8878]
RIN 1545-AU61
Tax Treatment of Cafeteria Plans
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final regulations.
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SUMMARY: This document contains final regulations relating to section
125 cafeteria plans. The final regulations clarify the circumstances
under which a section 125 cafeteria plan election may be changed. The
final regulations permit an employer to allow a section 125 cafeteria
plan participant to revoke an existing election and make a new election
during a period of coverage for accident or health coverage or group-
term life insurance coverage.
DATES: Effective Date: These regulations are effective March 23, 2000.
Applicability Date: These regulations are applicable for cafeteria
plan years beginning on or after January 1, 2001. See the Scope of
Regulations and Effective Date portion of this preamble.
FOR FURTHER INFORMATION CONTACT: Janet A. Laufer or Christine L. Keller
at (202) 622-6080 (not a toll-free number).
SUPPLEMENTARY INFORMATION:
Background
This document contains amendments to the Income Tax Regulations (26
CFR part 1) under section 125. Section 125 generally provides that an
employee in a cafeteria plan will not have an amount included in gross
income solely because the employee may choose among two or more
benefits consisting of cash and ``qualified benefits.'' A qualified
benefit generally is any benefit that is excludable from gross income
under an express provision of the Internal Revenue Code, including
coverage under an employer-provided accident or health plan under
sections 105 and 106, group-term life insurance under section 79,
elective contributions under a qualified cash or deferred arrangement
within the meaning of section 401(k), dependent care assistance under
section 129, and adoption assistance under section 137.\1\ Qualified
benefits can be provided under a cafeteria plan either through insured
arrangements or arrangements that are not insured.
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\1\ The following are not qualified benefits: products
advertised, marketed, or offered as long-term care insurance;
medical savings accounts under section 106(b); qualified scholarshps
under section 117; educational assistance programs under section
127; and fringe benefits under section 132.
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In 1984 and 1989, proposed regulations were published relating to
the administration of cafeteria plans.\2\ In general, the 1984 and 1989
proposed regulations require that for benefits to be provided on a pre-
tax basis under section 125, an employee may make changes during a plan
year only in certain circumstances.\3\ Specifically, Q&A-8 of
Sec. 1.125-1 and Q&A-6(b), (c), and (d) of Sec. 1.125-2 permit
participants to make benefit election changes during a plan year
pursuant to changes in cost or coverage, changes in family status, and
separation from service.
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\2\ 49 FR 19321 (May 7, 1984) and 54 FR 9460 (March 7, 1989),
respectively.
\3\ Those proposed regulations contain special rules with
respect to flexible spending arrangements. A flexible spending
arrangement (FSA) is defined in section 106(c)(2). Under section
106(c)(2), an FSA is generally a benefit program under which the
maximum reimbursement reasonably available for coverage is less than
500% of the value of the coverage.
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In 1997, temporary and proposed regulations were issued addressing
the standards under which a cafeteria plan may permit a participant to
change his or her group health coverage election during a period of
coverage to conform with the special enrollment rights under section
9801(f) (added to the Internal Revenue Code by the Health Insurance
Portability and Accountability Act of 1996 (HIPAA)) and to change his
or her group health or group-term life insurance coverage in a variety
of change in status situations.\4\
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\4\ 62 FR 60196 (November 7, 1997) and 62 FR 60165 (November 7,
1997), respectively. IRS Announcement 98-105 (1998-49 I.R.B. 21
(November 23, 1998)) states that the Service will amend the
effective date of those proposed and temporary regulations so that
they will not be effective before plan years beginning at least 120
days after further guidance is issued.
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These final regulations, which replace the 1997 temporary
regulations, clarify the circumstances under which a cafeteria plan may
permit an employee to revoke an existing election with respect to
accident or health coverage, or group-term life insurance coverage, and
make a new election during a period of coverage.
Explanation of Provisions
A. Summary
These regulations clarify the circumstances under which a cafeteria
plan may permit an employee to change his or her cafeteria plan
election with respect to accident or health coverage or group-term life
insurance coverage during the plan year. The regulations generally
follow the existing temporary regulations, and include a variety of
examples illustrating how the rules apply in specific situations.
The final regulations include two principal changes that have been
made in response to public comments. First, the regulations differ from
the 1997 regulations with respect to change in status events resulting
from a change in employment. Commentators requested a loosening of the
rules regarding when a cafeteria plan election can be changed. In
response, the final rules incorporate a more flexible rule under which
any change in the employment status of the employee (or a spouse or
dependent of the employee) that affects that individual's eligibility
under a cafeteria plan or qualified benefits plan constitutes a change
in status for purposes of permitting a mid-year election change.
Second, in the event of a change in an employee's marital status or the
employment status of the employee's spouse or dependent, the final
regulations permit the employee to elect either to increase group-term
life insurance coverage or to decrease group-term life insurance
coverage. A similar rule applies with respect to disability income
plans.
These final regulations were developed as part of an integrated
package with proposed regulations that are being published elsewhere in
this issue of the Federal Register. Those proposed regulations provide
guidance on election changes on account of changes in status with
respect to dependent care assistance and adoption assistance and
provide guidance on election changes on account of changes in cost or
coverage with respect to dependent care assistance, adoption
assistance, accident or health coverage, and group-term life insurance
coverage. The integrated package of final and proposed regulations is
intended to provide clear standards for plan administration and for
administration of the tax law. The standards are designed to
accommodate the most common types of events of independent significance
that do not occur on a regular, periodic basis and that are likely to
affect an employee's decisions with respect to qualified benefits
coverage.
B. Changes in Status
Commentators on the 1997 temporary and proposed regulations
requested that the description of changes in status be expanded to
include work-related changes of an employee, the employee's spouse, or
the employee's dependent in addition to termination or commencement of
employment or change in worksite. In response to these comments, the
description of changes in
[[Page 15549]]
status has been broadened to include a strike or lockout, and a
commencement of or return from an unpaid leave of absence. In addition,
the final rules incorporate a more flexible rule for other change in
employment status events. Specifically, if there is a change in the
employment status of the employee (or a spouse or dependent of the
employee) that affects that individual's eligibility under a cafeteria
plan or qualified benefits plan, then that change constitutes a change
in status. For example, if an employee switches from salaried to
hourly-paid status, resulting in the employee ceasing to be eligible
for coverage under the plan, then that change constitutes a change in
status.
Some commentators expressed concern that the 1997 temporary and
proposed regulations did not permit an employee to make an election
change to cover additional individuals under an accident or health plan
when an employer changed its policy (e.g., to permit coverage for a
parent or for a domestic partner pursuant to local law requirements).
Under the 1997 temporary and proposed regulations, a change in status
includes an event that causes an employee's dependent to satisfy or
cease to satisfy the eligibility requirements for coverage under a
plan. Thus, if an individual who is a dependent of an employee becomes
eligible for coverage under the employer's health plan as a result of
an amendment made to the plan during the year, that is a change in
status event and, accordingly, the cafeteria plan may permit an
election change by the employee to cover the individual. These final
regulations retain the rule from the 1997 temporary and proposed
regulations.
These final regulations do not address when a bona fide termination
of employment occurs. However, these regulations retain the example
(Example 8 under paragraph (c)(4) of these final regulations) from the
1997 temporary and proposed regulations addressing the situation in
which an employee terminates and resumes employment within 30 days. The
effect of this example is to provide a practical safe harbor that
generally may be applied by cafeteria plans without regard to other
facts and circumstances. Under this example, if an employee terminates
and resumes employment within 30 days and the cafeteria plan provides
that the employee's election is automatically reinstated, the employer
is not required to determine whether a bona fide change in status has
occurred with respect to termination of employment. Conversely, the
cafeteria plan may permit an employee who resumes employment more than
30 days following termination to be automatically reinstated to the
prior election or to make a new election.\5\
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\5\ Alternatively, the cafeteria plan may prohibit an employee
from participating in the cafeteria plan for that plan year upon
reemployment.
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C. Consistency Rule
As under the 1997 temporary and proposed regulations, the final
regulations require that an election change as a result of a change in
status also satisfy a consistency requirement. In response to comments,
the final regulations expand and clarify the consistency requirement
with respect to change in status events for group-term life insurance.
Under the 1997 regulations, in the case of a commencement of
employment, marriage, birth, adoption, or placement for adoption, an
employee could elect to increase (but not decrease) group-term life
insurance coverage. The 1997 regulations also permitted an employee to
elect to decrease (but not to increase) group-term life insurance
coverage in the case of divorce, legal separation, annulment, or death
of a spouse or dependent. Commentators suggested that these rules were
too restrictive. For example, in the case of divorce, an employee may
reasonably seek to increase coverage because the employee may become
the sole wage-earner for the family unit as a result of the divorce.
Accordingly, the final regulations provide flexibility by stating that,
in the event of a change in an employee's marital status or the
employment status of the employee's spouse or dependent, an employee
may elect either to increase group-term life insurance coverage or to
decrease group-term life insurance coverage. Also, in response to
comments, a similar rule has been added that applies to election
changes made with respect to disability income coverage (i.e., accident
or health coverage that is neither for medical care as defined under
section 213(d) nor for payments described in section 105(c)).
D. Other Changes
Some commentators requested that the regulations prescribe a period
of time by which election changes, as a result of a change in status,
should be made. Consistent with the approach taken in the 1997
regulations and in the interest of providing employers and plan
administrators flexibility, the final regulations do not prescribe such
a period. However, nothing in the final regulations would prevent a
cafeteria plan by its terms from requiring that any election change
(other than those made in connection with rights for which there are
specific minimum election periods, such as under section 9801 (as added
by HIPAA) and section 4980B (relating to COBRA coverage)), must be made
within a specified period after a change in status event. The
consistency rule in the final regulations does require that an election
change made pursuant to a change in status be ``on account of'' a gain
or loss of eligibility for coverage. This requirement follows the ``on
account of'' language contained in the 1989 proposed regulations under
Sec. 1.125-2, Q&A-6(c), and is intended to add a general condition that
the election change not be made so long after the event permitting the
election change that the election is not on account of the event.
In accordance with comments, examples in the regulations clarify
that if, in accordance with special enrollment rights provided by HIPAA
, an employee, spouse, or new dependent is entitled to enroll in a
group health plan, a cafeteria plan may permit the employee to elect to
enroll pre-existing dependents in the underlying group health plan.\6\
Likewise, the examples clarify that if, in accordance with the change
in status rules relating to a new spouse or dependent, an employee is
entitled to elect family coverage under a group health plan, then other
family members are permitted to become covered under the family
coverage as a result of the election change.\7\
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\6\ No inference is intended from these or any other examples in
the final regulations concerning the interpretation of special
enrollment rights under section 9801(f).
\7\ Provisions in paragraph (b) of the final regulation allowing
election changes in connection with special enrollment under section
9801(f) may overlap the provisions in paragraphs (c) through (e) of
the final regulations permitting election changes in other
circumstances. Thus, no inference is intended that an election
change permitted under paragraphs (c) through (e) is not also
permitted under paragraph (b).
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In response to comments, the final regulations also clarify that,
in the event of a loss of Medicare or Medicaid entitlement by an
employee or by the employee's spouse or dependent, a cafeteria plan may
permit the employee to add health coverage under the employer's
accident or health plan (and may permit cancellation or reduction in
coverage if an employee, spouse, or dependent who is enrolled in an
accident or health plan becomes entitled to Medicare or Medicaid).
Scope of Regulations and Effective Date
These final regulations address all of the changes in status for
which a cafeteria plan may permit election
[[Page 15550]]
changes with respect to an accident or health plan or group-term life
insurance plan. However, future guidance under the cost or coverage
change provision (reserved at paragraph (f) of these final regulations
and included in paragraph (f) of the proposed regulations being
published elsewhere in this issue of the Federal Register), rather than
the change in status rules, would determine whether a cafeteria plan
may permit affected employees to elect a new HMO option that is made
available during a period of coverage. Similarly, election changes may
be made under the special rules relating to changes in elections by
employees taking leave under the Family and Medical Leave Act of 1993
(Public Law 103-3) \8\ (as referenced at paragraph (g) of these final
regulations).
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\8\ See Sec. 1.125.3, published as a proposed rule at 60 FR
(December 21, 1995).
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Finally, these regulations do not override other cafeteria plan
requirements. For example, although an employee's termination of
employment is a change in status, some election changes made with
respect to coverage under a health FSA on account of the termination of
employment would fail to be consistent with the requirement that the
operation of such arrangements exhibit the risk-shifting and risk-
distribution characteristics of insurance under Sec. 1.125-1, Q&A-17
and Sec. 1.125-2, Q&A-7 of the proposed regulations. Thus, a cafeteria
plan could not permit individuals terminating employment to change
their health FSA elections to match the amount of premiums paid prior
to termination (i.e., stop paying premiums), and continue to receive
health FSA reimbursements with respect to the remainder of the period
of coverage.
These regulations are applicable for cafeteria plan years beginning
on or after January 1, 2001. Until the beginning of the first plan year
beginning on or after January 1, 2001, taxpayers may rely on these
regulations. In addition, until the beginning of the first plan year
beginning on or after January 1, 2001, taxpayers may continue to rely
on the change in status rules in the 1997 regulations, as well as the
change in family status rules in the pre-1997 proposed regulations.
Pursuant to section 7805(e), the 1997 temporary regulations
Sec. 1.125-4T will expire within three years of the date of issuance
(November 7, 2000). This Treasury decision amends the 1997 temporary
regulations to add this expiration in the text of the regulations
(Sec. 1.125-4T(l)).
Special Analyses
It has been determined that this Treasury decision is not a
significant regulatory action as defined in Executive Order 12866.
Therefore, a regulatory assessment is not required. It also has been
determined that section 553(b) of the Administrative Procedure Act (5
U.S.C. chapter 5) does not apply to these regulations, and because the
regulation does not impose a collection of information on small
entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not
apply. Pursuant to section 7805(f) of the Internal Revenue Code, these
regulations will be submitted to the Chief Counsel for Advocacy of the
Small Business Administration for comment on its impact on small
business.
Drafting Information: The principal authors of these regulations
are Janet A. Laufer and Christine L. Keller, Office of the Associate
Chief Counsel (Employee Benefits and Exempt Organizations). However,
other personnel from the IRS and Treasury Department participated in
their development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Adoption of Amendments to the Regulations
Accordingly, 26 CFR part 1 is amended as follows:
PART 1--INCOME TAXES
Paragraph 1. The authority citation for part 1 continues to read in
part as follows:
Authority: 26 U.S.C. 7805 * * *
Par. 2. Sec. 1.125-4 is added to read as follows:
Sec. 1.125-4 Permitted election changes.
(a) Election changes. A cafeteria plan may permit an employee to
revoke an election during a period of coverage and to make a new
election only as provided in paragraphs (b) through (g) of this
section. Section 125 does not require a cafeteria plan to permit any of
these changes. See paragraph (h) of this section for special provisions
relating to qualified cash or deferred arrangements, and paragraph (i)
of this section for special definitions used in this section.
(b) Special enrollment rights--(1) In general. A cafeteria plan may
permit an employee to revoke an election for coverage under a group
health plan during a period of coverage and make a new election that
corresponds with the special enrollment rights provided in section
9801(f).
(2) Examples. The following examples illustrate the application of
this paragraph (b):
Example 1. (i) Employer M provides health coverage for its
employees pursuant to a plan that is subject to section 9801(f).
Under the plan, employees may elect either employee-only coverage or
family coverage. M also maintains a calendar year cafeteria plan
under which qualified benefits, including health coverage, are
funded through salary reduction. M's employee, A, is married to B
and they have a child, C. In accordance with M's cafeteria plan,
Employee A elects employee-only health coverage before the beginning
of the calendar year. During the year, A and B adopt a child, D.
Within 30 days thereafter, A wants to revoke A's election for
employee-only health coverage and obtain family health coverage for
A's spouse, C, and D as of the date of D's adoption. Employee A
satisfies the conditions for special enrollment of an employee with
a new dependent under section 9801(f)(2), so that A may enroll in
family coverage under M's accident or health plan in order to
provide coverage effective as of the date of D's adoption.
(ii) M's cafeteria plan may permit A to change A's salary
reduction election to family coverage for salary not yet currently
available. The increased salary reduction is permitted to reflect
the cost of family coverage from the date of adoption. (A's adoption
of D is also a change in status, and the election of family coverage
is consistent with that change in status. Thus, under paragraph (c)
of this section, M's cafeteria plan could permit A to elect family
coverage prospectively in order to cover B, C, and D for the
remaining portion of the period of coverage.)
Example 2. (i) The employer plans and permissible coverage are
the same as in Example 1. Before the beginning of the calendar year,
Employee E elects employee-only health coverage under M's cafeteria
plan. Employee E marries F during the plan year. F's employer, N,
offers health coverage to N's employees, and, prior to the marriage,
F had elected employee-only coverage. Employee E wants to revoke the
election for employee-only coverage under M's cafeteria plan, and is
considering electing family health coverage under M's plan or
obtaining family health coverage under N's plan.
(ii) M's cafeteria plan may permit E to change E's salary
reduction election to reflect the change to family coverage under
M's group health plan because the marriage would result in special
enrollment rights under section 9801(f), pursuant to which an
election of family coverage under M's group health plan would be
required to be effective no later than the first day of the first
calendar month beginning after the completed request for enrollment
is received by the plan. (E's marriage to F is also a change in
status under paragraph (c) of this section, as illustrated in
Example 1 of paragraph (c)(4) of this section.)
(c) Changes in status--(1) In general--(i) Change in status rule. A
cafeteria plan may permit an employee to revoke an election during a
period of coverage with respect to a qualified benefits plan
[[Page 15551]]
to which this paragraph (c) applies and make a new election for the
remaining portion of the period (referred to in this section as an
election change) if, under the facts and circumstances--
(A) A change in status described in paragraph (c)(2) of this
section occurs; and
(B) The election change satisfies the consistency rule of paragraph
(c)(3) of this section.
(ii) Application to accident or health plans and group-term life
insurance plans. This paragraph (c) applies to plans providing accident
or health coverage and plans providing group-term life insurance
coverage.
(iii) Application to other qualified benefits. [Reserved]
(2) Change in status events. The following events are changes in
status for purposes of this paragraph (c):
(i) Legal marital status. Events that change an employee's legal
marital status, including the following: marriage; death of spouse;
divorce; legal separation; and annulment.
(ii) Number of dependents. Events that change an employee's number
of dependents, including the following: birth; death; adoption; and
placement for adoption.
(iii) Employment status. Any of the following events that change
the employment status of the employee, the employee's spouse, or the
employee's dependent: a termination or commencement of employment; a
strike or lockout; a commencement of or return from an unpaid leave of
absence; and a change in worksite. In addition, if the eligibility
conditions of the cafeteria plan or other employee benefit plan of the
employer of the employee, spouse, or dependent depend on the employment
status of that individual and there is a change in that individual's
employment status with the consequence that the individual becomes (or
ceases to be) eligible under the plan, then that change constitutes a
change in employment under this paragraph (c) (e.g., if a plan only
applies to salaried employees and an employee switches from salaried to
hourly-paid with the consequence that the employee ceases to be
eligible for the plan, then that change constitutes a change in
employment status under this paragraph (c)(2)(iii)).
(iv) Dependent satisfies or ceases to satisfy eligibility
requirements. Events that cause an employee's dependent to satisfy or
cease to satisfy eligibility requirements for coverage on account of
attainment of age, student status, or any similar circumstance.
(v) Residence. A change in the place of residence of the employee,
spouse, or dependent.
(3) Consistency rule--(i) Application to accident or health
coverage and group-term life insurance. An election change satisfies
the requirements of this paragraph (c)(3) with respect to accident or
health coverage or group-term life insurance only if the election
change is on account of and corresponds with a change in status that
affects eligibility for coverage under an employer's plan.
(ii) Application to other qualified benefits. [Reserved]
(iii) Application of consistency rule. If the change in status is
the employee's divorce, annulment or legal separation from a spouse,
the death of a spouse or dependent, or a dependent ceasing to satisfy
the eligibility requirements for coverage, an employee's election under
the cafeteria plan to cancel accident or health insurance coverage for
any individual other than the spouse involved in the divorce, annulment
or legal separation, the deceased spouse or dependent, or the dependent
that ceased to satisfy the eligibility requirements for coverage,
respectively, fails to correspond with that change in status. Thus, if
a dependent dies or ceases to satisfy the eligibility requirements for
coverage, the employee's election to cancel accident or health coverage
for any other dependent, for the employee, or for the employee's spouse
fails to correspond with that change in status. In addition, if an
employee, spouse, or dependent gains eligibility for coverage under a
family member plan (as defined in paragraph (i)(5) of this section) as
a result of a change in marital status under paragraph (c)(2)(i) of
this section or a change in employment status under paragraph
(c)(2)(iii) of this section, an employee's election under the cafeteria
plan to cease or decrease coverage for that individual under the
cafeteria plan corresponds with that change in status only if coverage
for that individual becomes applicable or is increased under the family
member plan. However, if the change in status is a change in the
employee's marital status under paragraph (c)(2)(i) of this section or
a change in the employment status of the employee's spouse or
dependents under paragraph (c)(2)(iii) of this section, an election to
increase, or an election to decrease, group-term life insurance or
disability income coverage corresponds with that change in status.
(iv) Exception for COBRA. If the employee, spouse, or dependent
becomes eligible for continuation coverage under the group health plan
of the employee's employer as provided in section 4980B or any similar
state law, a cafeteria plan may permit the employee to elect to
increase payments under the employer's cafeteria plan in order to pay
for the continuation coverage.
(4) Examples. The following examples illustrate the application of
this paragraph (c):
Example 1. (i) Employer M provides health coverage (including a
health FSA) for its employees through its cafeteria plan. Before the
beginning of the calendar year, Employee A elects employee-only
health coverage under M's cafeteria plan and elects salary reduction
contributions to fund coverage under the health FSA. Employee A
marries B during the year. Employee B's employer, N, offers health
coverage to N's employees (but not including any health FSA), and,
prior to the marriage, B had elected employee-only coverage.
Employee A wants to revoke the election for employee-only coverage,
and is considering electing family health coverage under M's plan or
obtaining family health coverage under N's plan.
(ii) Employee A's marriage to B is a change in status under
paragraph (c)(2)(i) of this section, pursuant to which B has become
eligible for coverage under M's health plan under paragraph
(c)(3)(i) of this section. Two possible election changes by A
correspond with the change in status: Employee A may elect family
health coverage under M's plan to cover A and B; or A may cancel
coverage under M's plan, if B elects family health coverage under
N's plan to cover A and B. Thus, M's cafeteria plan may permit A to
make either election change.
(iii) Employee A may also increase salary reduction
contributions to fund coverage for B under the health FSA.
Example 2. (i) Employee C, a single parent, elects family health
coverage under a calendar year cafeteria plan maintained by Employer
O. Employee C and C's 21-year old child, D, are covered under O's
health plan. During the year, D graduates from college. Under the
terms of the health plan, dependents over the age of 19 must be
full-time students to receive coverage. Employee C wants to revoke
C's election for family health coverage and obtain employee-only
coverage under O's cafeteria plan.
(ii) D's loss of eligibility for coverage under the terms of the
health plan is a change in status under paragraph (c)(2)(iv) of this
section. A revocation of C's election for family coverage and new
election for employee-only coverage corresponds with the change in
status. Thus, O's cafeteria plan may permit C to elect employee-only
coverage.
Example 3. (i) Employee E is married to F and they have one
child, G. Employee E is employed by Employer P, and P maintains a
calendar year cafeteria plan that allows employees to elect no
health coverage, employee-only coverage, employee-plus-one-dependent
coverage, or family coverage. Under the plan, before the beginning
of the calendar year, E elects family health coverage for E, F, and
G. E and F divorce during the year and F loses eligibility for
coverage under P's plan. G does not lose eligibility for health
coverage under P's plan upon the divorce. E
[[Page 15552]]
now wants to revoke E's election under the cafeteria plan and elect
no coverage.
(ii) The divorce is a change in status under paragraph
(c)(2)(i). A change in the cafeteria plan election to cancel health
coverage for F is consistent with that change in status. However, an
election change to cancel E's or G's health coverage does not
satisfy the consistency rule under paragraph (c)(3)(iii) of this
section regarding cancellation of coverage for an employee's other
dependents in the event of divorce. Therefore, the cafeteria plan
may not permit E to elect no coverage. However, an election to
change to employee-plus-one-dependent health coverage would
correspond with the change in status, and thus the cafeteria plan
may permit E to elect employee-plus-one-dependent health coverage.
Example 4. (i) Employer R maintains a calendar year cafeteria
plan under which full-time employees may elect coverage under one of
three benefit package options provided under an accident or health
plan: an indemnity option or either of two HMO options for employees
who work in the respective service areas of the two HMOs. Employee
A, who works in the service area of HMO #1, elects the HMO #1
option. During the year, A is transferred to another work location
which is outside the HMO #1 service area and inside the HMO #2
service area.
(ii) The transfer is a change in status under paragraph
(c)(2)(iii) of this section (relating to a change in worksite), and,
under the consistency rule in paragraph (c)(3) of this section, the
cafeteria plan may permit A to make an election change to either the
indemnity option or HMO #2.
Example 5. (i) Employer S maintains a calendar year cafeteria
plan that allows employees to elect coverage under an accident or
health plan providing indemnity coverage and coverage under a health
FSA. Prior to the beginning of the calendar year, Employee B elects
employee-only indemnity coverage, and elects salary reduction
contributions of $600 during the year to fund coverage under the
health FSA for up to $600 of reimbursements for the year. Employee
B's spouse, C, has employee-only coverage under an accident or
health plan maintained by C's employer. During the year, C
terminates employment and loses coverage under that plan. B now
wants to elect family coverage under S's accident or health plan and
increase B's FSA election.
(ii) C's termination of employment is a change in status under
paragraph (c)(2)(iii) of this section, and the election change
satisfies the consistency rule of paragraph (c)(3) of this section.
Therefore, the cafeteria plan may permit B to elect family coverage
under S's accident or health plan and to increase B's FSA coverage.
Example 6. (i) Employer T provides group-term life insurance
coverage as described under section 79. Under T's plan, an employee
may elect life insurance coverage in an amount up to $50,000. T also
maintains a calendar year cafeteria plan under which qualified
benefits, including the group-term life insurance coverage, are
funded through salary reduction. Employee D has a spouse and a
child. Before the beginning of the year, D elects $10,000 of group-
term life insurance coverage. During the year, D is divorced.
(ii) The divorce is a change in status under paragraph (c)(2)(i)
of this section. Under paragraph (c)(3)(iii) of this section, either
an increase or a decrease in coverage is consistent with this change
in status. Thus, T's cafeteria plan may permit D to increase or to
decrease D's group-term life insurance coverage.
Example 7. (i) Employee E is married to F and they have one
child, G. Employee E's employer, U, maintains a cafeteria plan under
which employees may elect no coverage, employee-only coverage, or
family coverage under a group health plan maintained by U, and may
make a separate vision coverage election under the plan. Before the
beginning of the calendar year, E elects family health coverage and
no vision coverage under U's cafeteria plan. Employee F's employer,
V, maintains a cafeteria plan under which employees may elect no
coverage, employee-only coverage, or family coverage under a group
health plan maintained by V, and may make a separate vision coverage
election under the plan. Before the beginning of the calendar year,
F elects no health coverage and employee-only vision coverage under
V's plan. During the year, F terminates employment with V and loses
vision coverage under V's plan. Employee E now wants to elect family
vision coverage under U's group health plan.
(ii) F's termination of employment is a change in status under
paragraph (c)(2)(iii) of this section, and the election change
satisfies the consistency rule of paragraph (c)(3) of this section.
Therefore, U's cafeteria plan may permit E to elect family vision
coverage (covering E and G as well as F) under U's group health
plan.
Example 8. (i) Before the beginning of the year, Employee H
elects to participate in a cafeteria plan maintained by H's
employer, W. However, in order to change the election during the
year so as to cancel coverage, and by prior understanding with W, H
terminates employment and resumes employment one week later.
(ii) In this Example 8, under the facts and circumstances, a
principal purpose of the termination of employment was to alter the
election, and reinstatement of employment was understood at the time
of termination. Accordingly, H does not have a change in status
under paragraph (c)(2)(iii) of this section.
(iii) However, H's termination of employment would constitute a
change in status, permitting a cancellation of coverage during the
period of unemployment, if H's original cafeteria plan election for
the period of coverage was reinstated upon resumption of employment
(for example, if W's cafeteria plan contains a provision requiring
an employee who resumes employment within 30 days, without any other
intervening event that would permit a change in election, to return
to the election in effect prior to termination of employment).
(iv) If, instead, H terminates employment and cancels coverage
during a period of unemployment, and then returns to work more than
30 days following termination of employment, the cafeteria plan may
permit H the option of returning to the election in effect prior to
termination of employment or making a new election under the plan.
Alternatively, the cafeteria plan may prohibit H from returning to
the plan during that plan year.
(d) Judgment, decree, or order--(1) Conforming election change.
This paragraph (d) applies to a judgment, decree, or order (order)
resulting from a divorce, legal separation, annulment, or change in
legal custody (including a qualified medical child support order as
defined in section 609 of the Employee Retirement Income Security Act
of 1974 (Public Law 93-406 (88 Stat. 829))) that requires accident or
health coverage for an employee's child or for a foster child who is a
dependent of the employee. A cafeteria plan will not fail to satisfy
section 125 if it--
(i) Changes the employee's election to provide coverage for the
child if the order requires coverage for the child under the employee's
plan; or
(ii) Permits the employee to make an election change to cancel
coverage for the child if the order requires the spouse, former spouse,
or other individual to provide coverage for the child.
(2) Example. The following example illustrates the application of
this paragraph (d):
Example. (i) Employer M maintains a calendar year cafeteria plan
that allows employees to elect no health coverage, employee-only
coverage, employee-plus-one-dependent coverage, or family coverage.
M's employee, A, is married to B and they have one child, C. Before
the beginning of the year, A elects employee-only health coverage.
Employee A divorces B during the year and, pursuant to A's divorce
agreement with B, M's health plan receives a qualified medical child
support order (as defined in section 609 of the Employee Retirement
Income Security Act of 1974) during the plan year. The order
requires M's health plan to cover C.
(ii) Under this paragraph (d), M's cafeteria plan may change A's
election from employee-only health coverage to employee-plus-one-
dependent coverage in order to cover C.
(e) Entitlement to Medicare or Medicaid. If an employee, spouse, or
dependent who is enrolled in an accident or health plan of the employer
becomes entitled to coverage (i.e., becomes enrolled) under Part A or
Part B of Title XVIII of the Social Security Act (Medicare) (Public Law
89-97 (79 Stat. 291)) or Title XIX of the Social Security Act
(Medicaid) (Public Law 89-97 (79 Stat. 343)), other than coverage
consisting solely of benefits under section 1928 of the Social Security
Act (the program for distribution of pediatric vaccines), a cafeteria
plan may permit the employee to make a prospective election change to
[[Page 15553]]
cancel or reduce coverage of that employee, spouse, or dependent under
the accident or health plan. In addition, if an employee, spouse, or
dependent who has been entitled to such coverage under Medicare or
Medicaid loses eligibility for such coverage, the cafeteria plan may
permit the employee to make a prospective election to commence or
increase coverage of that employee, spouse, or dependent under the
accident or health plan.
(f) Significant cost or coverage changes. [Reserved]
(g) Special requirements relating to the Family and Medical Leave
Act. An employee taking leave under the Family and Medical Leave Act
(FMLA) (Public Law 102-530 (88 Stat. 829)) may revoke an existing
election of group health plan coverage and make such other election for
the remaining portion of the period of coverage as may be provided for
under the FMLA.
(h) Elective contributions under a qualified cash or deferred
arrangement. The provisions of this section do not apply with respect
to elective contributions under a qualified cash or deferred
arrangement (within the meaning of section 401(k)) or employee
contributions subject to section 401(m). Thus, a cafeteria plan may
permit an employee to modify or revoke elections in accordance with
section 401(k) and (m) and the regulations thereunder.
(i) Definitions. Unless otherwise provided, the definitions in
paragraphs (i)(1) though (8) of this section apply for purposes of this
section.
(1) Accident or health coverage. Accident or health coverage means
coverage under an accident or health plan as defined in regulations
under section 105.
(2) Benefit package option. A benefit package option means a
qualified benefit under section 125(f) that is offered under a
cafeteria plan, or an option for coverage under an underlying accident
or health plan (such as an indemnity option, an HMO option, or a PPO
option under an accident or health plan).
(3) Dependent. A dependent means a dependent as defined in section
152, except that, for purposes of accident or health coverage, any
child to whom section 152(e) applies is treated as a dependent of both
parents.
(4) Disability income coverage. Disability income coverage means
coverage under an accident or health plan that provides benefits due to
personal injury or sickness, but does not reimburse expenses incurred
for medical care (as defined in section 213(d)) of the employee or the
employee's spouse and dependents, and does not provide for payments
described in section 105(c).
(5) Family member plan. A family member plan means a cafeteria plan
or qualified benefit plan sponsored by the employer of the employee's
spouse or the employee's dependent.
(6) FSA, health FSA. An FSA means a qualified benefits plan that is
a flexible spending arrangement as defined in section 106(c)(2) . A
health FSA means a health or accident plan that is an FSA.
(7) Placement for adoption. Placement for adoption means placement
for adoption as defined in regulations under section 9801.
(8) Qualified benefits plan. A qualified benefits plan means an
employee benefit plan governing the provision of one or more benefits
that are qualified benefits under section 125(f).
(j) Effective date. This section is applicable for cafeteria plan
years beginning on or after January 1, 2001.
Par. 3. Sec. 1.125-4T is amended by revising paragraph (l) to read
as follows:
Sec. 1.125-4T Permitted election changes (temporary).
* * * * *
(l) Effective date. This section is applicable for plan years
beginning after December 31, 1998, and on or before November 6, 2000.
Robert E. Wenzel,
Deputy Commissioner of Internal Revenue.
Approved: February 23, 2000.
Jonathan Talisman,
Acting Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 00-5817 Filed 3-22-00; 8:45 am]
BILLING CODE 4830-01-U