Review of Recent Guidance on the Impact of Health Reform on Cafeteria Plans

By Larry Grudzien, J.D.
Oct. 29, 2013

On September 13, 2013, the Internal Revenue Service (IRS) issued Notice 2013-54 and the Department of Labor (DOL) issued Technical Release 2013-03. The two pieces of guidance are substantially identical and address many previously unanswered questions regarding how market reform and other provisions of the Affordable Care Act (Act) apply to health reimbursement arrangements (HRAs), including HRAs integrated with group health plans; health flexible spending arrangements (health FSAs); and employee assistance programs (EAPs).

The following series of questions and answers will review how these two pieces of guidance affect premium only plans (POPs) and health FSAs only in 2014.

1.    In 2014, can an employer allow employees to pre-tax premiums for individual medical coverages purchased either inside or outside the public exchanges (marketplace)?

No. Code Section 125(f)(3), has been amended effective for taxable years beginning in 2014 to prohibit employees from purchasing coverage through a public Exchange on a pre-tax basis using the employer’s cafeteria plan (but, employees may still purchase coverage on a SHOP Exchange on a pre-tax basis using the employer’s cafeteria plan if the employer offers SHOP coverage to its employees).

 For any individual health coverage purchased outside of the exchange, any pre-tax reimbursement of individual medical premiums under a POP would constitute an employer payment plan and would be disallowed.

Code Section 125 merely provides for the non-taxability of the choice between cash and pre-tax benefits.  Code Section 125 does not provide the actual exclusion from employee income for employer-provided health coverage. That exclusion is reserved exclusively under Code Section 106.  For tax (but not ERISA) purposes, amounts deducted from employees’ pay under a cafeteria plan election are treated as employer contributions.  This is so because employee deferrals are made under a salary reduction agreement-the employee agrees to a reduction in salary in a specified amount and the employer agrees to contribute a like amount toward the purchase of qualified benefits (medical coverage, in this instance).  
Therefore, any employee pre-tax contributions to a POP will be treated as employer funds and payment of premium by the employer with those funds (which are excluded from the employee’s gross income under Code Section 106) essentially becomes an employer payment plan.  Employer payment plans for individual coverage fail Q&A-1 in Part III of IRS Notice 2013-54.  This guidance provides that any employer payment plan, that reimburses employees for an employee’s substantiated individual insurance policy premiums must satisfy the market reforms for group health plans. However, the employer payment plan will fail to comply with the annual dollar limit prohibition because (1) an employer payment plan is considered to impose an annual limit up to the cost of the individual market coverage purchased through the arrangement, and (2) an employer payment plan cannot be integrated with any individual health insurance policy purchased under the arrangement.

2.    Can an employee be reimbursed on a pre-tax basis under a POP for individual premiums for benefits other than medical coverage?

Yes.  The above restrictions only apply to individual medical coverage. Under Proposed. Treasury Regulations Section 1.125-1(m)(1), it is possible to pre-tax individual premiums for dental, vision, disability, accidental death and dismemberment (AD&D), cancer insurance, hospital indemnity, and supplemental life insurance coverage, to name just a few.  Please remember making a cafeteria plan available for individual policies (or paying for any portion of the premiums) raises issues under the Internal Revenue HIPAA, ERISA, COBRA, and other laws.

3.    Which health FSAs are not subject to the Act and the market reforms in 2014?

IRS Notice makes clear that the Act’s market reform requirements do not apply to health FSAs that meet the “excepted benefit” definition.

A health FSA is considered an excepted benefit for a “class of participants” if the health FSA is a health FSA under Code Section 106(c)(2) and satisfies two conditions:

•    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), as provided in Treasury Regulations Section 54.9831-1(c)(3)(v)(B); DOL Regulations Section 2590.732(c)(3)(v)(B); and HHS Regulations Section 146.145(c)(3)(v)(B); and

•    Availability Condition: Other nonexcepted 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, as provided in Treasury Regulations Section 54.9831-1(c)(3)(v)(A); DOL Regulations Section 2590.732(c)(3)(v)(A); and HHS Regulations Section146.145(c)(3)(v)(A).

Neither the regulations nor the preamble to the regulations explains what is meant by the term “class of participants.” The term appears to preclude a “participant-by-participant” approach to determining whether benefits under a health FSA are excepted benefits.
Examples of Health FSA Funding That Meet the Maximum Benefit Condition:

•    A one-for-one employer match (employer $600, employee $600).

•    An employer contribution of $500 or less (employer $500, employee $200).

Examples of Health FSA Funding That Do Not Meet the Maximum Benefit Condition:
•    An employer contribution of more than $500, if the employee contributes $500 or less (employer $600, employee $400).

•    An employer contribution in excess of a one-to-one match, if the employee contributes more than $500 (employer contributes $700, employee contributes $600).
Remember: Health FSAs funded exclusively by employee salary reduction contributions (with annual coverage capped by the amount of the annual salary reduction election) will, by definition, satisfy the Maximum Benefit Condition.

4.    In 2014, can an employer still offer a stand-alone Health FSA?

Yes, so long as the stand-alone health FSA qualifies as HIPAA-excepted. For a stand-alone health FSA to be considered to provide only excepted benefits, it must meet one of the following designs:

•    Limited scope dental and vision benefits that are not an integral part of a group health plan are excepted benefits.

•    If other group health plan coverage not limited to excepted benefits is made available for the year to employees by the employer, and the FSA is structured so that the maximum benefit payable to any participant cannot exceed two times the participant’s salary reduction election for the arrangement for the year (or, if greater, cannot exceed $500 plus the amount of the participant’s salary reduction election).

5.     If a health FSA is considered to be a non-excepted benefit, what are the consequences?

A health FSA that does not qualify as an excepted benefit is generally subject to the Act’s market reforms, including the preventive services requirements, unless it is grandfathered. The IRS and DOL had previously ruled that a health FSA is not subject to the annual dollar limit prohibition, irrespective of whether the health FSA provides only excepted benefits. Because a health FSA that is not an excepted benefit is not integrated with a group health plan, it will fail to meet the preventive services requirements, unless it is grandfathered.
For failure to meet the Act’s market reforms, an employer could also be subject to fines and penalties.

Larry Grudzien 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 of experience in employee benefit law and is an adjunct faculty member of John Marshall Law School’s LL.M. program in employee benefits and at the Valparaiso University School of Law, where he teaches a number of courses.