[Federal Register Volume 60, Number 245 (Thursday, December 21, 1995)]
[Proposed Rules]
[Pages 66229-66233]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-30681]



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DEPARTMENT OF THE TREASURY
26 CFR Part 1

[EE-20-95]
RIN 1545-AT47


Effect of the Family and Medical Leave Act on the Operation of 
Cafeteria Plans

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking.

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SUMMARY: This document contains proposed regulations relating to 
cafeteria plans that reflect changes made by the Family and Medical 
Leave Act of 1993. The proposed regulations provide the public with 
guidance needed to comply with the Act and affect employees who 
participate in cafeteria plans.

DATES: Written comments and requests for a public hearing must be 
received by March 20, 1996.

ADDRESSES: Send submissions to: CC:DOM:CORP:R (EE-20-95), room 5228, 
Internal Revenue Service, POB 7604, Ben Franklin Station, Washington, 
DC 20044. In the alternative, submissions may be hand delivered between 
the hours of 8 a.m. and 5 p.m. to: CC:DOM:CORP:R (EE-20-95), Courier's 
Desk, Internal Revenue Service, 1111 Constitution Avenue NW., 
Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Catherine 
Fuller, (202) 622-6080; concerning submissions and the hearing, Mike 
Slaughter, (202) 622-8452 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

    This document contains proposed additions to the Income Tax 
Regulations (26 CFR Part 1) under section 125 of the Internal Revenue 
Code of 1986 (Code). These additions are proposed to conform the 
regulations to the Family and Medical Leave Act of 1993 (FMLA), Public 
Law 103-3. FMLA imposes certain requirements on employers regarding 
coverage, including family coverage, under group health plans for 
employees taking FMLA leave, and regarding the restoration of benefits 
to employees who return from FMLA leave. This notice of proposed 
rulemaking addresses a number of the principle questions that have been 
raised about how these FMLA requirements affect the operation of 
cafeteria plans (including flexible spending arrangements) maintained 
under section 125 of the Code. The rules in this notice of proposed 
rulemaking supplement the proposed Income Tax Regulations under section 
125 of the Code. Except as otherwise provided in this notice of 
proposed rulemaking, all of the existing rules governing cafeteria 
plans, including the nondiscrimination rules, continue to apply.
    The requirements pertaining to FMLA leave, including the employer's 
obligation to maintain coverage under a group health plan during FMLA 
leave and to restore benefits upon return from FMLA leave, are 
established by FMLA, 

[[Page 66230]]
not the Code. The U.S. Department of Labor, in 29 CFR part 825, has 
published rules interpreting the requirements of FMLA, and the 
Department of Labor has jurisdiction relating to those rights or 
obligations. This notice of proposed rulemaking does not interpret 
FMLA; it provides guidance on the cafeteria plan rules that apply to an 
employee in circumstances to which FMLA and the Labor Regulations 
thereunder also apply. The Department of Labor has advised the 
Department of the Treasury, including the Internal Revenue Service 
(IRS), that the provisions of this notice of proposed rulemaking do not 
conflict with, and are not inconsistent with, the provisions of FMLA or 
the Labor Regulations thereunder.

Special Analyses

    It has been determined that this notice of proposed rulemaking is 
not a significant regulatory action as defined in EO 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) and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do 
not apply to these regulations, and, therefore, a Regulatory 
Flexibility Analysis is not required. Pursuant to section 7805(f) of 
the Code, this notice of proposed rulemaking will be submitted to the 
Chief Counsel for Advocacy of the Small Business Administration for 
comment on its impact on small business.

Comments and Requests for a Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any written comments (a signed original 
and eight (8) copies) that are submitted timely to the IRS. All 
comments will be available for public inspection and copying. A public 
hearing may be scheduled if requested in writing by a person that 
timely submits written comments. If a public hearing is scheduled, 
notice of the date, time, and place for the hearing will be published 
in the Federal Register.

Drafting Information

    The principal author of these regulations is Catherine Fuller, 
Office of Associate Chief Counsel (Employee Benefits and Exempt 
Organizations). However, other personnel from the IRS and Department of 
the Treasury participated in their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

    Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

    Paragraph 1. The authority for part 1 continues to read in part as 
follows:

    Authority: 26 U.S.C. 7805 * * *

    Par.Section 1.125-3 is added to read as follows:

Sec. 1.125-3  Effect of the Family and Medical Leave Act (FMLA) on the 
operation of cafeteria plans.

    Q-1: May an employee taking FMLA leave revoke an existing election 
of group health plan coverage under a cafeteria plan?
    A-1: Yes. An employee taking FMLA leave may revoke an existing 
election of group health plan coverage (including a health flexible 
spending arrangement (FSA)) under a cafeteria plan for the remaining 
portion of the coverage period. See 29 CFR 825.209(e). FMLA also 
requires that an employee be permitted to choose to be reinstated in 
the group health plan coverage (including a health FSA) provided under 
a cafeteria plan upon returning from FMLA leave if the employee's group 
health plan coverage terminated while on FMLA leave (either by 
revocation or nonpayment of premiums). Such an employee is entitled, 
under FMLA, to be reinstated on the same terms as prior to taking FMLA 
leave (including family or dependent coverage). See 29 CFR 825.209(e) 
and 825.215(d). However, the employee has no greater right to benefits 
for the remainder of the plan year than an employee who has been 
continuously working during the plan year. In addition to the rights 
granted under FMLA, such an employee has the right to revoke or change 
elections (e.g., because of changes in family status or significant 
cost or coverage changes imposed by a third-party provider) under the 
same terms and conditions as are available to employees participating 
in the cafeteria plan who are not on FMLA leave.
    Q-2: Who is responsible for making premium payments under a 
cafeteria plan when an employee on FMLA leave continues group health 
plan coverage?
    A-2: An employee is entitled to continue group health plan coverage 
(including a health FSA) during FMLA leave whether or not provided 
under a health FSA or other component of a cafeteria plan. See 29 CFR 
825.209(b). An employee making premium payments under a cafeteria plan 
who chooses to continue group health plan coverage (including a health 
FSA) while on FMLA leave is responsible for the share of group health 
premiums that the employee was paying while working, such as amounts 
paid pursuant to a salary reduction agreement. The employer must 
continue to contribute the share of the cost of the employee's coverage 
that the employer was paying before the employee commenced FMLA leave. 
See 29 CFR 825.100(b) and 825.210(a).
    Q-3: What payment options are required or permitted to be offered 
under a cafeteria plan to an employee who continues group health plan 
coverage (including a health FSA) while on unpaid FMLA leave, and what 
is the tax treatment of these payments?
    A-3: (a) In general A cafeteria plan may, on a nondiscriminatory 
basis, offer one or more of the following payment options (subject to 
the limitations described in paragraph (b) of this Q&A-3) to an 
employee who continues group health plan coverage (including a health 
FSA) while on unpaid FMLA leave. These options are referred to in this 
section as pre-pay, pay-as-you-go and catch-up.
    (1) Pre-pay. (i) Under the pre-pay option, a cafeteria plan may 
permit an employee to pay, prior to commencement of the FMLA leave 
period, the amounts due for the FMLA leave period. However, the Labor 
Regulations under FMLA provide that under no circumstances may the 
employer mandate that an employee pre-pay the amounts due for the leave 
period. See 29 CFR 825.210(c)(3) and (4).
    (ii) Contributions under the pre-pay option may be made on a pre-
tax salary reduction basis from any taxable compensation (including the 
cashing out of unused sick days or vacation days). These contributions 
will not be included in the employee's gross income, provided that all 
cafeteria plan requirements are satisfied. For example, see Q&A-5 of 
this section regarding restrictions on pre-tax salary reduction 
contributions when an employee's FMLA leave spans two cafeteria plan 
years.
    (iii) Contributions under the pre-pay option may also be made on an 
after-tax basis. See Prop. Treas. Reg. Sec. 1.125-1, Q&A-5.\1\

    \1\ Published as a proposed rule at 49 FR 19321 (May 7, 1984).
    
[[Page 66231]]

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    (2) Pay-as-you-go. (i) Under the pay-as-you-go option, employees 
may pay their share of the premium payments on the same schedule as 
payments would be made if the employee were not on leave or under any 
other payment schedule permitted by the Labor Regulations at 29 CFR 
825.210(c) (i.e., on the same schedule as payments are made under the 
Consolidated Omnibus Reconciliation Act of 1985, Public Law 99-272; 
under the employer's existing rules for payment by employees on leave 
without pay; or under any other system voluntarily agreed to between 
the employer and the employee that is not inconsistent with this 
section or with 29 CFR 825.210(c)).
    (ii) Contributions under the pay-as-you-go option are generally 
made by the employee on an after-tax basis. However, contributions may 
be made on a pre-tax basis to the extent that the contributions are 
made from taxable compensation (e.g., cashing out unused sick or 
vacation days) that is due the employee during the leave period, and 
provided that all cafeteria plan requirements are satisfied.
    (iii) An employer is not required to continue the health coverage 
of an employee who fails to make required premium payments while on 
FMLA leave. See 29 CFR 825.212. However, if the employer chooses to 
continue the health coverage of an employee who fails to make required 
premium payments while on FMLA leave, the employer is entitled to 
recoup those payments as set forth in paragraph (a)(3)(i) of this Q&A-
3. See also Q&A-6 of this section regarding coverage under a health FSA 
when an employee fails to make the required premium payments while on 
FMLA leave.
    (3) Catch-up. (i) An employer that continues providing group health 
coverage to an employee who does not pay premiums on FMLA leave is, to 
the extent provided under the Labor Regulations, permitted to utilize 
the catch-up option to recoup the employee's share of premium payments. 
See, e.g., 29 CFR 825.212(b).
    (ii) Where an employee is electing to use the catch-up option, the 
employer and the employee must agree in advance of the coverage period 
that: the employee elects to continue health coverage while on unpaid 
FMLA leave; the employer will assume responsibility for advancing 
payment of the premiums on the employee's behalf during the FMLA leave; 
and these advance amounts must be paid by the employee when the 
employee returns from FMLA leave.
    (iii) Contributions under the catch-up option may be made on a pre-
tax salary reduction basis when the employee returns from FMLA leave 
from any available taxable compensation (including the cashing out of 
unused sick days and vacation days). These contributions will not be 
included in the employee's gross income, provided that all cafeteria 
plan requirements are satisfied.
    (iv) Contributions under the catch-up option may also be made on an 
after-tax basis. See Prop. Treas. Reg. Sec. 1.125-1, Q&A-5.\2\

    \2\ Published as a proposed rule at 49 FR 19321 (May 7, 1984).
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    (b) Exceptions. Cafeteria plans may offer (pursuant to 29 CFR 
825.210(c)) one or more of the payment options described in paragraph 
(a) of this Q&A-3, with the following exceptions:
    (1) The pre-pay option cannot be the sole option offered to 
employees on FMLA leave. However, the cafeteria plan may include pre-
payment as an option for employees on FMLA leave, even if such option 
is not offered to employees on non-FMLA leave- without-pay.
    (2) The catch-up option can be the sole option offered to employees 
on FMLA leave if and only if the catch-up option is the sole option 
offered to employees on non-FMLA leave-without-pay.
    (3) A cafeteria plan cannot offer employees on FMLA leave a choice 
of either the pre-pay option or the catch-up option without also 
offering the pay-as-you-go option, if the pay-as-you- go option is 
offered to employees on non-FMLA leave-without-pay.
    (c) Voluntary waiver of employee payments. In addition to the 
foregoing payment options, an employer may voluntarily waive, on a 
nondiscriminatory basis, the requirement that employees who elect to 
continue health coverage while on FMLA leave pay the amounts the 
employees would otherwise be required to pay for the leave period.
    Q-4: Do the special FMLA requirements concerning an employee who 
continues group health plan coverage under a cafeteria plan apply if 
the employee is on paid FMLA leave?
    A-4: No. The Labor Regulations provide that, if an employee's FMLA 
leave is substituted paid leave as described at 29 CFR 825.207 and the 
employee continues group health plan coverage while on FMLA leave, the 
employee's share of the premiums must be paid by the method normally 
used during any paid leave (i.e., salary reduction). See 29 CFR 
825.210(b).
    Q-5: What restrictions apply to contributions when an employee's 
FMLA leave spans two cafeteria plan years?
    A-5: (a) Contributions to a cafeteria plan during FMLA leave will 
not be included in an employee's gross income, provided that the plan 
complies with all cafeteria plan requirements. Among other 
requirements, a plan may not operate in a manner that enables employees 
on FMLA leave to defer compensation from one cafeteria plan year to a 
subsequent cafeteria plan year. See Prop. Treas. Reg. Sec. 1.125-2, 
Q&A-5.\3\

    \3\ Published as a proposed rule at 54 FR 9460 (March 7, 1989).
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    (b) The following example illustrates this Q&A-5:

    Example. Employee A elects health coverage under a calendar year 
cafeteria plan maintained by Employer X. A's premium for health 
coverage is $100 per month throughout the 12-month period of 
coverage. A takes FMLA leave for 12 weeks beginning on October 31 
after making 10 months worth of premiums totalling $1000 (10 months 
x  $100 = $1000). A maintains health coverage while on FMLA leave. A 
utilizes the pre-pay option by cashing-out A's unused sick days in 
order to make the required premium payments due while A is on FMLA 
leave. Because A cannot defer compensation from one plan year to a 
subsequent plan year, A may pre-pay the premiums due in November and 
December (i.e., $100 per month) on a pre-tax basis, but A cannot 
pre-pay the premium payment due in January on a pre-tax basis. If A 
participates in the cafeteria plan in the subsequent plan year, A 
must use another option (e.g., pay-as-you-go or catch-up) to make 
the premium payment due in January.

    Q-6: Are there special rules concerning employees taking FMLA leave 
who participate in health FSAs offered under a cafeteria plan?
    A-6: (a) In general. (1) A health plan that is a flexible spending 
arrangement (FSA) offered under a cafeteria plan must conform to the 
generally applicable rules in this section concerning employees who 
take FMLA leave. Thus, FMLA requires that an employee taking FMLA leave 
be permitted to--
    (i) Continue coverage under a health FSA while on FMLA leave; or
    (ii) Revoke an existing health FSA election under the cafeteria 
plan for the remainder of the coverage period. See 29 CFR 825.209(e).
    (2) FMLA also requires the plan to permit the employee to be 
reinstated in the health FSA upon return from FMLA leave on the same 
terms as prior to taking FMLA leave. See 29 CFR 825.215(d) and 
paragraph (b)(2) of this Q&A-6. However, reinstatement is at the 
employee's election and under no circumstances may an employer require 

[[Page 66232]]
an employee whose coverage has terminated while on FMLA leave to 
reinstate coverage under a health FSA upon return from FMLA leave. See 
29 CFR 825.214(a).
    (b) Uniform Coverage Rule (1) Q&A-7(b)(2) of Sec. 1.125-2\4\ (the 
uniform coverage rule) applies during the FMLA leave period as long as 
the employee continues health coverage. Therefore, regardless of the 
payment option selected under Q&A-3 of this section, for so long as the 
employee continues coverage (or for so long as the employer continues 
the coverage of an employee who fails to make the required 
contributions as described in Q&A-3(a)(2)(iii) of this section), the 
full amount of the elected coverage, less any prior reimbursements, 
must be available to the employee at all times, including the FMLA 
leave period.

    \4\ Published as a proposed rule at 54 FR 9460 (March 7, 1989).
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    (2)(i) If an employee's coverage under the health FSA terminates 
while the employee is on FMLA leave, the employee is not entitled to 
receive reimbursements for claims incurred during the period when the 
coverage is terminated. If that employee subsequently elects to be 
reinstated in the health FSA upon return from FMLA leave for the 
remainder of the plan year, the employee may not retroactively elect 
health FSA coverage for claims incurred during the period when the 
coverage was terminated. Further, the employee is not entitled to 
greater FSA benefits relative to premiums paid than an employee who has 
been continuously working during the plan year. See 29 CFR 825.216. 
Therefore, if an employee elects to be reinstated in a health FSA upon 
return from FMLA leave, the employee's coverage for the remainder of 
the plan year is equal to the employee's election for the 12-month 
period of coverage (or such shorter period as provided under 
Sec. 1.125-2 \5\), prorated for the period during the FMLA leave for 
which no premiums were paid, and reduced by prior reimbursements.

    \5\ Published as a proposed rule at 54 FR 9460 (March 7, 1989).
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    (ii) An employee on FMLA leave has the right to revoke or change 
elections (e.g., because of changes in family status) under the same 
terms and conditions that apply to employees participating in the 
cafeteria plan who are not on FMLA leave. Thus, notwithstanding the 
rules described in paragraph (b)(2)(i) of this Q&A-6, an employee who 
returns from FMLA leave may make a new health FSA election for the 
remainder of the plan year if return from leave without pay constitutes 
a change of family status under the employer's cafeteria plan.
    (3) The following examples illustrate the rules in this Q&A-6:

    Example 1: (a) Employee A elects $1200 worth of coverage under a 
calendar year health FSA provided under a cafeteria plan, with an 
annual premium of $1200. A is permitted to pay the $1200 through 
pre-tax salary reduction amounts of $100 per month throughout the 
12-month period of coverage. A incurs no medical expenses prior to 
April 1. On April 1, A takes FMLA leave after making three months 
worth of contributions totalling $300 (3 months  x  $100 = $300). 
The plan does not permit a revocation of election on account of a 
change in family status. However, pursuant to A's rights under FMLA, 
A elects to terminate coverage upon going on FMLA leave. 
Consequently, A makes no premium payments for the months of April, 
May, and June, and A is not entitled to submit claims or receive 
reimbursements for expenses incurred during this period. A returns 
from FMLA leave and elects to be reinstated in the health FSA on 
July 1.
    (b) Under FMLA, A has no greater right to benefits upon 
reinstatement than if A had been continuously working during the 
plan year. Therefore, A is reinstated to A's annual election (i.e., 
$1200) prorated for the period during the FMLA leave for which no 
premiums were paid (i.e., reduced for 3 months or \1/4\ of the plan 
year) less prior reimbursements (i.e., $0). Consequently, A's 
coverage for the remainder of the plan year equals $900. A must also 
begin making premium payments of $100 per month for the remainder of 
the plan year.
    Example 2: Assume the same facts as Example 1 except that A 
incurs medical expenses totaling $200 in February and obtains 
reimbursement of these expenses. The results are the same as in 
Example 1, except that A's coverage for the remainder of the plan 
year equals $700.
    Example 3: Assume the same facts as Example 1 except that prior 
to taking FMLA leave, A elects to continue health FSA coverage 
during the FMLA leave. The plan permits A (and A elects) to use the 
catch-up payment option described in Q&A-3 of this section, and as 
further permitted under the plan, A chooses to repay the $300 in 
missed payments on a ratable basis over the remaining six-month 
period of coverage (i.e., $50 per month). Thus, A's monthly premium 
payments for the remainder of the plan year will be $150 ($100 + 
$50).

    Q-7: Are employees entitled to non-health benefits while taking 
FMLA leave?
    A-7: FMLA does not require an employer to maintain an employee's 
non-health benefits (e.g., life insurance) during FMLA leave. An 
employee's entitlement to benefits other than group health benefits 
under a cafeteria plan during a period of FMLA leave is to be 
determined by the employer's established policy for providing such 
benefits when the employee is on non-FMLA leave (paid or unpaid). See 
29 CFR 825.209(h). Therefore, an employee who takes FMLA leave is 
entitled to revoke an election of non-health benefits under a cafeteria 
plan to the same extent employees taking non-FMLA leave are permitted 
to revoke elections of non-health benefits under a cafeteria plan. For 
example, election changes are permitted due to changes of family status 
or upon enrollment for a new plan year. See Sec. 1.125-2, Q&A-6(c) \6\ 
and Sec. 1.125-1, Q&A-8.\7\ However, the FMLA regulations provide that, 
in certain cases, an employer may continue an employee's non-health 
benefits under the employer's cafeteria plan while the employee is on 
FMLA leave to ensure that the employer can meet its responsibility to 
provide equivalent benefits to the employee upon return from unpaid 
FMLA. If the employer continues an employee's non-health benefits 
during FMLA leave, the employer is entitled to recoup the costs 
incurred for paying the employee's share of the premiums during the 
FMLA leave period. See 29 CFR 825.213(b). In addition, a cafeteria plan 
must, as required by FMLA, permit an employee whose coverage terminated 
while on FMLA leave (either by revocation or nonpayment of premiums) to 
be reinstated in the cafeteria plan on return from FMLA leave. See 29 
CFR 825.214(a) and 825.215(d).

    \6\ Published as a proposed rule at 54 FR 9460 (March 7, 1989).
    \7\ Published as a proposed rule at 49 FR 19321 (May 7, 1984).
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    Q-8: How may taxpayers rely on these proposed regulations?
    A-8: (a) The guidance provided by the questions and answers in this 
section may be relied upon to comply with provisions of section 125 and 
will be applied by the Internal Revenue Service in resolving issues 
arising under cafeteria plans and related Internal Revenue Code 
sections. If final regulations are more restrictive than the guidance 
in this section, the regulations will not be applied retroactively. No 
inference, however, should be drawn regarding issues not expressly 
raised that may be suggested by a particular question or answer or by 
the inclusion or exclusion of certain questions.
    (b) The Department of Labor has advised the Department of the 
Treasury, including the Internal Revenue Service, that the provisions 
of this section are not inconsistent with the provisions of 

[[Page 66233]]
FMLA and the Labor Regulations thereunder.
Margaret Milner Richardson,
Commissioner of Internal Revenue.
[FR Doc. 95-30681 Filed 12-20-95; 8:45 am]
BILLING CODE 4830-01-U