[Federal Register Volume 66, Number 7 (Wednesday, January 10, 2001)]
[Rules and Regulations]
[Pages 1837-1843]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 01-258]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[TD 8921]
RIN 1545-AY23
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 cafeteria plan may permit an employee to change his or
her cafeteria plan election with respect to accident or health
coverage, group-term life insurance coverage, dependent care assistance
and adoption assistance during the plan year.
DATES: Effective Date: These regulations are effective January 10,
2001.
Applicability Date: See the Scope of Regulations and Effective Date
portion of this preamble.
FOR FURTHER INFORMATION CONTACT: Christine L. Keller or Janet A. Laufer
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 of the Internal Revenue Code (Code).
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 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\ Section 125(f) provides that the following are not qualified
benefits (even though they are generally excludable from gross
income under an express provision of the Internal Revenue Code:
Products advertised, marketed, or offered as long-term care
insurance; medical savings accounts under section 106(b); qualified
scholarships 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
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. 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,
[[Page 1838]]
changes in family status, and separation from service.
In 2000, final regulations \3\ were issued permitting a participant
in a cafeteria plan to change his or her accident or health coverage
election during a period of coverage in specific circumstances such as
where special enrollment rights arise under section 9801(f) (added to
the Code by the Health Insurance Portability and Accountability Act of
1996 (HIPAA)(110 Stat. 1936), where eligibility for Medicare or
Medicaid is gained or lost, or where a court issues a judgment, decree,
or order requiring that an employee's child or foster child who is a
dependent receive health coverage. In addition, the final regulations
permit an employee to change his or her accident or health coverage
election or group-term life insurance election if certain change in
status rules are satisfied.
On the same day that the final regulations were issued, proposed
regulations \4\ were also issued containing change in status rules that
apply to other types of qualified benefits (i.e., dependent care
assistance and adoption assistance) and describing the circumstances
under which changes in the cost or coverage of qualified benefits
provide a basis for changes in cafeteria plan elections. The IRS and
Treasury received written comments on the proposed regulations and held
a public hearing on August 17, 2000. Having considered the comments and
the statements made at the hearing, the IRS and Treasury revise the
final regulations and adopt the proposed regulations as modified by
this Treasury decision. The comments and revisions are discussed below.
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\2\ 49 FR 19321 (May 7, 1984) and 54 FR 9460 (March 7, 1989),
respectively.
\3\ TD 8878 at 65 FR 15548 (March 23, 2000). These final
regulations were preceded by temporary regulations issued in 1997.
See 62 FR 60196 (November 7, 1997) and 62 FR 60165 (November 7,
1997).
\4\ REG-117162-99 at 65 FR 15587 (March 23, 2000).
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Explanation of Provisions
1. Changes in the March 2000 Final Regulations
With respect to group-term life insurance and disability coverage,
the final regulations issued earlier this year provided flexibility by
stating that, in the event of a change in an employee's marital status
or a change in the employment status of the employee's spouse or
dependent, an employee may elect either to increase such coverage or to
decrease such coverage.\5\ Commentators recommended that this rule also
apply in the case of birth, adoption, placement for adoption, or death.
The argument was made that in these other situations--because these
types of coverage are generally designed to provide income, instead of
expense reimbursements--it may be appropriate for the employee to seek
to increase or decrease the coverage. In accordance with these
recommendations and in the interest of simplicity, the final
regulations have been modified to allow participants to increase or
decrease these types of coverage for all change of status events.
Further, as also suggested by commentators, the final regulations have
been modified to expand the rule to apply to coverage to which section
105(c) (which is coverage for permanent loss or loss of use of a member
or function of the body) applies.
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\5\ For example, an employee might seek to increase group-item
life insurance due to a marriage (because of the need to provide
income to the new spouse in the event that the chief wage-earner
dies) or to decrease group-term life insurance due to a marriage
(because the new spouse may be a wage-earner who can support the
family in the event that the employee dies).
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Commentators requested clarification as to how the election change
rules with respect to special enrollment rights under section 9801(f)
(enacted under HIPAA) apply to a participant who marries if the group
health plan allows the participant to change his or her health coverage
election retroactively to the date of the marriage. In response to this
comment, language has been added to an example in the final regulations
to clarify that an election change can be funded through salary
reduction under a cafeteria plan only on a prospective basis, except
for the retroactive enrollment right under section 9801(f) that applies
in the case of an election made within 30 days of a birth, adoption, or
placement for adoption.
With respect to accident or health coverage, the consistency rule
in the final regulations requires that any employee who wishes to
decrease or cancel coverage because he or she becomes eligible for
coverage under a spouse's or dependent's plan due to a marital or
employment change in status can do so only if he or she actually
obtains coverage under that other plan. Commentators requested
clarification as to the type of proof an employer must receive to
satisfy this rule, expressing concern that a plan could not implement a
change on a timely basis because of a need to obtain proper proof of
the other coverage. An example in the final regulations has been
revised to make it clear that employers may generally rely on an
employee's certification that the employee has or will obtain coverage
under the other plan (assuming that the employer has no reason to
believe that the employee certification is incorrect).
The final regulations allow a participant to change his or her
election if a judgment, decree or order resulting from a divorce, legal
separation, annulment, or change in legal custody requires that an
employee's spouse, former spouse, or other individual provide accident
or health coverage for the employee's child or for a foster child who
is a dependent of the employee. The final regulations were modified to
clarify that the participant can only change his or her election if the
spouse, former spouse, or other individual actually provides accident
or health coverage for the child.
2. Changes From the March 2000 Proposed Regulations
The final regulations being issued today are generally consistent
with the proposed regulations that were issued earlier this year, but
include various modifications.
Cost and coverage rules
The proposed regulations included rules allowing election changes
in connection with a significant increase in cost or a significant
curtailment in coverage, irrespective of whether the plan is insured or
not insured. These cost and coverage rules (and the other rules in
paragraph (f) of Sec. 1.125-4) do not apply with respect to coverage
under a health FSA.\6\ However, all of the rules in paragraphs (a)
through (e) and paragraph (g) of the final regulations under
Sec. 1.125-4 do apply with respect to coverage under a health FSA. One
modification reflected in the final regulations is to clarify that the
cost increase rules apply when the amount of an employee's elective
contributions under section 125 increases either due to the employee
contributing a larger portion of the total cost of the qualified
benefits plan (which might occur, for example, if part-time employees
pay a larger portion of a plan's cost and the employee switches to
part-time status) or due to an increase in the total cost of the
qualified benefits plan.
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\6\ 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. A
health FSA is an accident or health plan that is an FSA.
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In response to comments, modifications were also made to allow
election changes during a period of coverage when there is a
significant decrease in the cost of a qualified benefits plan or in the
cost of a benefits package option under the qualified
[[Page 1839]]
benefits plan, as well as when there is a significant increase. Under
the regulations as modified, if there is a significant decrease in the
cost of a qualified benefits plan during the plan year, the final
regulations permit a cafeteria plan to allow all employees, even those
who have not previously participated in the cafeteria plan, to elect to
participate in the qualified benefits plan through the cafeteria plan.
Similarly, if there is a significant decrease in the cost of a benefits
package option during the plan year, the final regulations permit a
cafeteria plan to allow all eligible employees to elect that option
(including employees who have elected another option, as well as those
who have not previously participated in the cafeteria plan).
Further, in response to comments, modifications were also made to
allow midyear election changes when there is a significant improvement
in the coverage provided under a benefit package option, as well as
when there is a new benefit package option offered under the plan.
Commentators also requested clarification as to whether a cafeteria
plan could allow participants to drop coverage in response to a
significant change in the cost or coverage of a qualified benefit. The
final regulations clarify this issue, and provide that, if there is no
other similar coverage, employees may drop coverage (including a change
from family to single coverage) in response either to an increase in
the cost of a qualified benefit or to a loss of coverage. The
regulations also permit an employee to elect similar coverage in
response to a significant curtailment in coverage. However, the
regulations do not allow an employee to drop coverage altogether if
there is a significant curtailment in coverage that does not constitute
a loss of coverage. The regulations list the curtailments that are
treated as a loss of coverage for this purpose, and include a complete
loss of coverage (such as when an HMO ceases to be available in an area
where an individual resides, or when an employee or a covered member of
the employee's family loses all coverage under a benefit package option
by reason of a lifetime or annual limitation). In addition, the final
regulations allow a cafeteria plan, in its discretion,\7\ to treat
certain other events as a loss of coverage. These events include a
substantial decrease in medical care providers (such as a major
hospital ceasing to be a member of a preferred provider network or a
substantial decease in the physicians participating in a preferred
provider network or an HMO), a reduction in the benefits for a specific
type of medical condition or treatment with respect to which the
employee or the employee's spouse or dependent is currently in a course
of treatment,\8\ or any other similar fundamental loss of coverage.
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\7\ Such discretion may be exercised on a case by case basis,
provided that the exercise of discretion satisfies section 125(c)
which prohibits discrimination in favor of highly compensated
participants.
\8\ Any reduction in coverage that affects a specific individual
must not violate the prohibition in section 9802 against
discrimination on the basis of health status (and parallel HIPAA
provisions in the Employee Retirment Income Security Act of 1974 and
the Public Health Service Act). See Secs. 54.9802-1 and 54.9802-
1T(b)(2).
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For purposes of these rules, a significant curtailment occurs only
if there is an overall reduction in coverage provided so as to
constitute reduced coverage generally (i.e., a reduction in the fair
market value of the coverage). Therefore, in most cases, the loss of
one particular physician in a network does not constitute a significant
curtailment.
In response to comments, the rule under the proposed regulations
that allowed an employee to change his or her election in response to a
change made under a spouse's or dependent's plan has been clarified and
broadened. Under the final regulations, the rule applies to coverage
available from any employer plan, including any plan of the same
employer and any plan of a different employer. In addition, the
regulations have been modified to allow an employee to elect to
participate in a cafeteria plan if the employee (or the employee's
spouse or dependent) loses coverage under a group health plan sponsored
by a governmental or educational institution, such as a state program
under the State Children Health Insurance Program (SCHIP).\9\ The
regulations do not allow a cafeteria plan participant to cease
participation in a cafeteria plan if he or she becomes eligible for
SCHIP coverage during the year because of a concern that such a rule
would violate a fundamental principle of Title XXI of the Social
Security Act that SCHIP coverage not supplant existing public or
private coverage.
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\9\ Added to the Society Security Act by section 4901 of the
Balanced Budget Act of 1997, Public Law 105-33 (August 5, 1997).
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Scope of Regulations and Effective Date
These final regulations address all of the changes in status for
which a cafeteria plan may permit election changes, including changes
with respect to accident or health coverage, group-term life insurance,
dependent care assistance and adoption assistance. In addition, the
regulations contain guidance concerning election changes that are
permitted because of changes in the cost or coverage of a qualified
benefit plan.
Unless specifically noted, these regulations do not override other
cafeteria plan requirements such as the rules pertaining to health
flexible spending arrangements, and the rules concerning the Family and
Medical Leave Act (Public Law 103-3 (107 Stat. 6)).\10\
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\10\ See Sec. 1.125-3, published as a proposed rule at 60 FR
66229 (December 21, 1995).
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The changes made by these regulations with respect to the March
2000 final regulations are applicable for cafeteria plan years
beginning on or after January 1, 2001, except that the clarification
made in paragraph (d)(1)(ii)(B) of these regulations (relating to a
spouse, former spouse, or other individual obtaining accident or health
coverage for an employee's child in response to a judgment, decree, or
order) is applicable for cafeteria plan years beginning on or after
January 1, 2002. With respect to the change made in paragraph
(d)(1)(ii)(B) of these regulations, taxpayers may, until January 1,
2002, rely on either paragraph (d)(1)(ii)(B) of these regulations or
the final regulations published in March 2000 (as Sec. 1.125-
4(d)(1)(ii)).
The changes made from the March 2000 proposed regulations
(including the rules relating to cost or coverage in paragraph (f) of
these regulations) are applicable for cafeteria plan years beginning on
or after January 1, 2002. With respect to these changes (including the
rules relating to cost or coverage in paragraph (f) of these
regulations), taxpayers may, until January 1, 2002, rely on either
these regulations, the proposed regulations published in March 2000
(under Sec. 1.125-4), or the cost or coverage change rules in the 1989
proposed regulations (at Sec. 1.125-2 (Q&A-6(b)).
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
[[Page 1840]]
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 Christine L. Keller
and Janet A. Laufer, Office of Division Counsel/Associate Chief Counsel
(Tax Exempt and Government Entities). 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. 1.125-4 is amended by:
1. Revising paragraphs (b)(2) Example 2(ii).
2. Revising paragraph (c)(1) and adding paragraph (c)(2)(vi).
3. Adding a sentence to the end of paragraph (c)(3)(i).
4. Removing the last sentence in paragraph (c)(3)(iii) and adding a
sentence in its place.
5. Adding paragraph (c)(4) Example 3 (iii).
6. Revising paragraph (c)(4) Example 4 (ii) and adding paragraph
(iii).
7. Adding paragraph (c)(4) Example 9 and (c)(4) Example 10.
8. Revising paragraph (d)(1)(ii).
9. Revising paragraphs (f), (g), (i)(3) and (i)(4).
10. Adding a sentence at the end of paragraph (i)(8), and adding
paragraph (i)(9).
11. Revising paragraph (j).
The additions and revisions read as follows:
Sec. 1.125-4 Permitted election changes.
* * * * *
(b) * * *
(2) * * *
Example 2. * * *
(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 accident or 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 accident or 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. Since no retroactive coverage is
required in the event of marriage under section 9801(f), E's salary
reduction election may only be changed on a prospective basis. (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) 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 (defined in
paragraph (i)(8) of this section) 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--
(i) A change in status described in paragraph (c)(2) of this
section occurs; and
(ii) The election change satisfies the consistency rule of
paragraph (c)(3) of this section.
* * * * *
(2) * * *
(vi) Adoption assistance. For purposes of adoption assistance
provided through a cafeteria plan, the commencement or termination of
an adoption proceeding.
(3) Consistency rule--(i) Application to accident or health
coverage and group-term life insurance. * * * A change in status that
affects eligibility under an employer's plan includes a change in
status that results in an increase or decrease in the number of an
employee's family members or dependents who may benefit from coverage
under the plan.
* * * * *
(iii) Application of consistency rule. * * * With respect to group-
term life insurance and disability coverage (as defined in paragraph
(i)(4) of this section), an election under a cafeteria plan to increase
coverage (or an election to decrease coverage) in response to a change
in status described in paragraph (c)(2) of this section is deemed to
correspond with that change in status as required by paragraph
(c)(3)(i) of this section.
(4) * * *
Example 3. * * *
(iii) In addition, under paragraph (f)(4) of this section, if F
makes an election change to cover G under F's employer's plan, then
E may make a corresponding change to elect employee-only coverage
under P's cafeteria plan.
Example 4. * * *
(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 elect the
indemnity option or HMO #2 or to cancel accident or health coverage.
(iii) The change in work location has no effect on A's
eligibility under R's health FSA, so no change in A's health FSA is
authorized under this paragraph (c).
* * * * *
Example 9. (i) Employee A has one child, B. Employee A's
employer, X, maintains a calendar year cafeteria plan that allows
employees to elect coverage under a dependent care FSA. Prior to the
beginning of the calendar year, A elects salary reduction
contributions of $4,000 during the year to fund coverage under the
dependent care FSA for up to $4,000 of reimbursements for the year.
During the year, B reaches the age of 13, and A wants to cancel
coverage under the dependent care FSA.
(ii) When B turns 13, B ceases to satisfy the definition of
qualifying individual under section 21(b)(1) of the Internal Revenue
Code. Accordingly, B's attainment of age 13 is a change in status
under paragraph (c)(2)(iv) of this section that affects A's
employment-related expenses as defined in section 21(b)(2).
Therefore, A may make a corresponding change under X's cafeteria
plan to cancel coverage under the dependent care FSA.
Example 10. (i) Employer Y maintains a calendar year cafeteria
plan under which full-time employees may elect coverage under either
an indemnity option or an HMO. Employee C elects the employee-only
indemnity option. During the year, C marries D. D has two children
from a previous marriage, and has family group health coverage in a
cafeteria plan sponsored by D's employer, Z. C wishes to change from
employee-only indemnity coverage to HMO coverage for the family. D
wishes to cease coverage in Z's group health plan and certifies to Z
that D will have family coverage under C's plan (and Z has no reason
to believe the certification is incorrect).
(ii) The marriage is a change in status under paragraph
(c)(2)(i) of this section. Under the consistency rule in paragraph
(c)(3) of this section, Y's cafeteria plan may permit C to change
his or her salary reduction contributions to reflect the change from
employee-only indemnity to HMO family coverage, and Z may permit D
to revoke coverage under Z's cafeteria plan.
(d) * * * (1) * * *
(ii) Permits the employee to make an election change to cancel
coverage for the child if:
(A) The order requires the spouse, former spouse, or other
individual to provide coverage for the child; and
(B) That coverage is, in fact, provided.
* * * * *
(f) Significant cost or coverage changes--(1) In general.
Paragraphs (f)(2) through (5) of this section set forth rules for
election changes as a result of changes in cost or coverage. This
paragraph (f) does not apply to an
[[Page 1841]]
election change with respect to a health FSA (or on account of a change
in cost or coverage under a health FSA).
(2) Cost changes--(i) Automatic changes. If the cost of a qualified
benefits plan increases (or decreases) during a period of coverage and,
under the terms of the plan, employees are required to make a
corresponding change in their payments, the cafeteria plan may, on a
reasonable and consistent basis, automatically make a prospective
increase (or decrease) in affected employees' elective contributions
for the plan.
(ii) Significant cost changes. If the cost charged to an employee
for a benefit package option (as defined in paragraph (i)(2) of this
section) significantly increases or significantly decreases during a
period of coverage, the cafeteria plan may permit the employee to make
a corresponding change in election under the cafeteria plan. Changes
that may be made include commencing participation in the cafeteria plan
for the option with a decrease in cost, or, in the case of an increase
in cost, revoking an election for that coverage and, in lieu thereof,
either receiving on a prospective basis coverage under another benefit
package option providing similar coverage or dropping coverage if no
other benefit package option providing similar coverage is available.
For example, if the cost of an indemnity option under an accident or
health plan significantly increases during a period of coverage,
employees who are covered by the indemnity option may make a
corresponding prospective increase in their payments or may instead
elect to revoke their election for the indemnity option and, in lieu
thereof, elect coverage under another benefit package option including
an HMO option (or drop coverage under the accident or health plan if no
other benefit package option is offered).
(iii) Application of cost changes. For purposes of paragraphs
(f)(2)(i) and (ii) of this section, a cost increase or decrease refers
to an increase or decrease in the amount of the elective contributions
under the cafeteria plan, whether that increase or decrease results
from an action taken by the employee (such as switching between full-
time and part-time status) or from an action taken by an employer (such
as reducing the amount of employer contributions for a class of
employees).
(iv) Application to dependent care. This paragraph (f)(2) applies
in the case of a dependent care assistance plan only if the cost change
is imposed by a dependent care provider who is not a relative of the
employee. For this purpose, a relative is an individual who is related
as described in section 152(a)(1) through (8), incorporating the rules
of section 152(b)(1) and (2).
(3) Coverage changes--(i) Significant curtailment without loss of
coverage. If an employee (or an employee's spouse or dependent) has a
significant curtailment of coverage under a plan during a period of
coverage that is not a loss of coverage as described in paragraph
(f)(3)(ii) of this section (for example, there is a significant
increase in the deductible, the copay, or the out-of-pocket cost
sharing limit under an accident or health plan), the cafeteria plan may
permit any employee who had been participating in the plan and
receiving that coverage to revoke his or her election for that coverage
and, in lieu thereof, to elect to receive on a prospective basis
coverage under another benefit package option providing similar
coverage. Coverage under a plan is significantly curtailed only if
there is an overall reduction in coverage provided under the plan so as
to constitute reduced coverage generally. Thus, in most cases, the loss
of one particular physician in a network does not constitute a
significant curtailment.
(ii) Significant curtailment with loss of coverage. If an employee
(or the employee's spouse or dependent) has a significant curtailment
that is a loss of coverage, the plan may permit that employee to revoke
his or her election under the cafeteria plan and, in lieu thereof, to
elect either to receive on a prospective basis coverage under another
benefit package option providing similar coverage or to drop coverage
if no similar benefit package option is available. For purposes of this
paragraph (f)(3)(ii), a loss of coverage means a complete loss of
coverage under the benefit package option or other coverage option
(including the elimination of a benefits package option, an HMO ceasing
to be available in the area where the individual resides, or the
individual losing all coverage under the option by reason of an overall
lifetime or annual limitation). In addition, the cafeteria plan may, in
its discretion, treat the following as a loss of coverage--
(A) A substantial decrease in the medical care providers available
under the option (such as a major hospital ceasing to be a member of a
preferred provider network or a substantial decrease in the physicians
participating in a preferred provider network or an HMO);
(B) A reduction in the benefits for a specific type of medical
condition or treatment with respect to which the employee or the
employee's spouse or dependent is currently in a course of treatment;
or
(C) Any other similar fundamental loss of coverage.
(iii) Addition or improvement of a benefit package option. If a
plan adds a new benefit package option or other coverage option, or if
coverage under an existing benefit package option or other coverage
option is significantly improved during a period of coverage, the
cafeteria plan may permit eligible employees (whether or not they have
previously made an election under the cafeteria plan or have previously
elected the benefit package option) to revoke their election under the
cafeteria plan and, in lieu thereof, to make an election on a
prospective basis for coverage under the new or improved benefit
package option.
(4) Change in coverage under another employer plan. A cafeteria
plan may permit an employee to make a prospective election change that
is on account of and corresponds with a change made under another
employer plan (including a plan of the same employer or of another
employer) if--
(i) The other cafeteria plan or qualified benefits plan permits
participants to make an election change that would be permitted under
paragraphs (b) through (g) of this section (disregarding this paragraph
(f)(4)); or
(ii) The cafeteria plan permits participants to make an election
for a period of coverage that is different from the period of coverage
under the other cafeteria plan or qualified benefits plan.
(5) Loss of coverage under other group health coverage. A cafeteria
plan may permit an employee to make an election on a prospective basis
to add coverage under a cafeteria plan for the employee, spouse, or
dependent if the employee, spouse, or dependent loses coverage under
any group health coverage sponsored by a governmental or educational
institution, including the following--
(i) A State's children's health insurance program (SCHIP) under
Title XXI of the Social Security Act;
(ii) A medical care program of an Indian Tribal government (as
defined in section 7701(a)(40)), the Indian Health Service, or a tribal
organization
(iii) A State health benefits risk pool; or
(iv) A Foreign government group health plan.
(6) Examples. The following examples illustrate the application of
this paragraph (f):
Example 1. (i) A calendar year cafeteria plan is maintained
pursuant to a collective
[[Page 1842]]
bargaining agreement for the benefit of Employer M's employees. The
cafeteria plan offers various benefits, including indemnity health
insurance and a health FSA. As a result of mid-year negotiations,
premiums for the indemnity health insurance are reduced in the
middle of the year, insurance co-payments for office visits are
reduced under the indemnity plan by an amount which constitutes a
significant benefit improvement, and an HMO option is added.
(ii) Under these facts, the reduction in health insurance
premiums is a reduction in cost. Accordingly, under paragraph
(f)(2)(i) of this section, the cafeteria plan may automatically
decrease the amount of salary reduction contributions of affected
participants by an amount that corresponds to the premium change.
However, the plan may not permit employees to change their health
FSA elections to reflect the mid-year change in copayments under the
indemnity plan.
(iii) Also, the decrease in co-payments is a significant benefit
improvement and the addition of the HMO option is an addition of a
benefit package option. Accordingly, under paragraph (f)(3)(ii) of
this section, the cafeteria plan may permit eligible employees to
make an election change to elect the indemnity plan or the new HMO
option. However, the plan may not permit employees to change their
health FSA elections to reflect differences in co-payments under the
HMO option.
Example 2. (i) Employer N sponsors an accident or health plan
under which employees may elect either employee-only coverage or
family health coverage. The 12-month period of coverage under N's
cafeteria plan begins January 1, 2001. N's employee, A, is married
to B. Employee A elects employee-only coverage under N's plan. B's
employer, O, offers health coverage to O's employees under its
accident or health plan under which employees may elect either
employee-only coverage or family coverage. O's plan has a 12-month
period of coverage beginning September 1, 2001. B maintains
individual coverage under O's plan at the time A elects coverage
under N's plan, and wants to elect no coverage for the plan year
beginning on September 1, 2001, which is the next period of coverage
under O's accident or health plan. A certifies to N that B will
elect no coverage under O's accident or health plan for the plan
year beginning on September 1, 2001 and N has no reason to believe
that A's certification is incorrect.
(ii) Under paragraph (f)(4)(ii) of this section, N's cafeteria
plan may permit A to change A's election prospectively to family
coverage under that plan effective September 1, 2001.
Example 3. (i) Employer P sponsors a calendar year cafeteria
plan under which employees may elect either employee-only or family
health coverage. Before the beginning of the year, P's employee, C,
elects family coverage under P's cafeteria plan. C also elects
coverage under the health FSA for up to $200 of reimbursements for
the year to be funded by salary reduction contributions of $200
during the year. C is married to D, who is employed by Employer Q. Q
does not maintain a cafeteria plan, but does maintain an accident or
health plan providing its employees with employee-only coverage.
During the calendar year, Q adds family coverage as an option under
its health plan. D elects family coverage under Q's plan, and C
wants to revoke C's election for health coverage and elect no health
coverage under P's cafeteria plan for the remainder of the year.
(ii) Q's addition of family coverage as an option under its
health plan constitutes a new coverage option described in paragraph
(f)(3)(ii) of this section. Accordingly, pursuant to paragraph
(f)(4)(i) of this section, P's cafeteria plan may permit C to revoke
C's health coverage election if D actually elects family health
coverage under Q's accident or health plan. Employer P's plan may
not permit C to change C's health FSA election.
Example 4. (i) Employer R maintains a cafeteria plan under which
employees may elect accident or health coverage under either an
indemnity plan or an HMO. Before the beginning of the year, R's
employee, E elects coverage under the HMO at a premium cost of $100
per month. During the year, E decides to switch to the indemnity
plan, which charges a premium of $140 per month.
(ii) E's change from the HMO to indemnity plan is not a change
in cost or coverage under this paragraph (f), and none of the other
election change rules under paragraphs (b) through (e) of this
section apply.
(iii) Although R's health plan may permit E to make the change
from the HMO to the indemnity plan, R's cafeteria plan may not
permit E to make an election change to reflect the increased
premium. Accordingly, if E switches from the HMO to the indemnity
plan, E may pay the $40 per month additional cost on an after-tax
basis.
Example 5. (i) Employee A is married to Employee B and they have
one child, C. Employee A's employer, M, maintains a calendar year
cafeteria plan that allows employees to elect coverage under a
dependent care FSA. Child C attends X's on site child care center at
an annual cost of $3,000. Prior to the beginning of the year, A
elects salary reduction contributions of $3,000 during the year to
fund coverage under the dependent care FSA for up to $3,000 of
reimbursements for the year. Employee A now wants to revoke A's
election of coverage under the dependent care FSA, because A has
found a new child care provider.
(ii) The availability of dependent care services from the new
child care provider (whether the new provider is a household
employee or family member of A or B or a person who is independent
of A and B) is a significant change in coverage similar to a benefit
package option becoming available. Because the FSA is a dependent
care FSA rather than a health FSA, the coverage rules of this
section apply and M's cafeteria plan may permit A to elect to revoke
A's previous election of coverage under the dependent care FSA, and
make a corresponding new election to reflect the cost of the new
child care provider.
Example 6. (i) Employee D is married to Employee E and they have
one child, F. Employee D's employer, N, maintains a calendar year
cafeteria plan that allows employees to elect coverage under a
dependent care FSA. Child F is cared for by Y, D's household
employee, who provides child care services five days a week from 9
a.m. to 6 p.m. at an annual cost in excess of $5,000. Prior to the
beginning of the year, D elects salary reduction contributions of
$5,000 during the year to fund coverage under the dependent care FSA
for up to $5,000 of reimbursements for the year. During the year, F
begins school and, as a result, Y's regular hours of work are
changed to five days a week from 3 p.m. to 6 p.m. Employee D now
wants to revoke D's election under the dependent care FSA, and make
a new election under the dependent care FSA to an annual cost of
$4,000 to reflect a reduced cost of child care due to Y's reduced
hours.
(ii) The change in the number of hours of work performed by Y is
a change in coverage. Thus, N's cafeteria plan may permit D to
reduce D's previous election under the dependent care FSA to $4,000.
Example 7. (i) Employee G is married to Employee H and they have
one child, J. Employee G's employer, O, maintains a calendar year
cafeteria plan that allows employees to elect coverage under a
dependent care FSA. Child J is cared for by Z, G's household
employee, who is not a relative of G and who provides child care
services at an annual cost of $4,000. Prior to the beginning of the
year, G elects salary reduction contributions of $4,000 during the
year to fund coverage under the dependent care FSA for up to $4,000
of reimbursements for the year. During the year, G raises Z's
salary. Employee G now wants to revoke G's election under the
dependent care FSA, and make a new election under the dependent care
FSA to an annual amount of $4,500 to reflect the raise.
(ii) The raise in Z's salary is a significant increase in cost
under paragraph (f)(2)(ii) of this section, and an increase in
election to reflect the raise corresponds with that change in
status. Thus, O's cafeteria plan may permit G to elect to increase
G's election under the dependent care FSA.
Example 8. (i) Employer P maintains a calendar year cafeteria
plan that allows employees to elect employee-only, employee plus one
dependent, or family coverage under an indemnity plan. During the
middle of the year, Employer P gives its employees the option to
select employee-only or family coverage from an HMO plan. P's
employee, J, who had elected employee plus one dependent coverage
under the indemnity plan, decides to switch to family coverage under
the HMO plan.
(ii) Employer P's midyear addition of the HMO option is an
addition of a benefit package option. Under paragraph (f) of this
section, Employee J may change his or her salary reduction
contributions to reflect the change from indemnity to HMO coverage,
and also to reflect the change from employee plus one dependent to
family coverage (however, an election of employee-only coverage
under the new option would not correspond with the addition of a new
option). Employer P may not permit J to change J's health FSA
election.
[[Page 1843]]
(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 103-3 (107 Stat. 6)) may revoke an existing election
of accident or 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.
* * * * *
(i) * * *
(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, and, for purposes of dependent care assistance provided
through a cafeteria plan, a dependent means a qualifying individual (as
defined in section 21(b)(1)) with respect to the employee.
(4) Disability coverage. Disability 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. For purposes of this section,
disability coverage includes payments described in section 105(c).
* * * * *
(8) Qualified benefits plan. * * * A plan does not fail to be a
qualified benefits plan merely because it includes an FSA, assuming
that the FSA meets the requirements of section 125 and the regulations
thereunder.
(9) Similar coverage. Coverage for the same category of benefits
for the same individuals (e.g., family to family or single to single).
For example, two plans that provide coverage for major medical are
considered to be similar coverage. For purposes of this definition, a
health FSA is not similar coverage with respect to an accident or
health plan that is not a health FSA. A plan may treat coverage by
another employer, such as a spouse's or dependent's employer, as
similar coverage.
(j) Effective date--(1) General rule. Except as provided in
paragraph (j)(2) of this section, this section is applicable for
cafeteria plan years beginning on or after January 1, 2001.
(2) Delayed effective date for certain provisions. The following
provisions are applicable for cafeteria plan years beginning on or
after January 1, 2002: paragraph (c) of this section to the extent
applicable to qualified benefits other than an accident or health plan
or a group-term life insurance plan; paragraph (d)(1)(ii)(B) of this
section (relating to a spouse, former spouse, or other individual
obtaining accident or health coverage for an employee's child in
response to a judgment, decree, or order); paragraph (f) of this
section (rules for election changes as a result of cost or coverage
changes); and paragraph (i)(9) of this section (defining similar
coverage).
Sec. 1.125-4T [Removed]
Par. 3. Section 1.125-4T is removed.
Robert E. Wenzel,
Deputy Commissioner of Internal Revenue.
Approved: December 15, 2000.
Jonathan Talisman,
Acting Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 01-258 Filed 1-9-01; 8:45 am]
BILLING CODE 4830-01-P