[Federal Register Volume 62, Number 216 (Friday, November 7, 1997)]
[Rules and Regulations]
[Pages 60165-60168]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-29087]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[TD 8738]
RIN 1545-AV43
Tax Treatment of Cafeteria Plans
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Temporary regulations.
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SUMMARY: This document contains temporary regulations that clarify the
circumstances under which an employer may permit a cafeteria plan
participant to revoke an existing election and make a new election
during a period of coverage. The text of these temporary regulations
also serves as the text of the proposed regulations set forth in the
notice of proposed rulemaking on this subject in the proposed rules
section of this issue of the Federal Register.
DATES: These regulations are effective on December 31, 1998.
FOR FURTHER INFORMATION CONTACT: Sharon Cohen, (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. These temporary regulations provide
guidance relating to the circumstances under which a cafeteria plan
participant may revoke an existing election and make a new election
during a period of coverage.
Explanation of Provisions
A ``cafeteria plan'' under section 125 allows an employee to choose
between cash and certain nontaxable benefits, such as accident or
health coverage. Section 125 generally permits the employee to choose
the nontaxable benefit (rather than the available cash) without the
employee having to include the available cash in gross income. The
temporary regulations:
Permit a cafeteria plan to allow an employee, during a
plan year, to change his or her health coverage election to conform
with the new special enrollment rights provided under the Health
Insurance Portability and Accountability Act of 1996 (HIPAA), and
Permit a cafeteria plan to allow a change in coverage
election for a variety of other changes in status.
These regulations are designed to provide clear, administrable
guidelines for determining when changes can be made in cafeteria plan
elections during a plan year.
These regulations are effective for plan years beginning after
December 31, 1998. However, taxpayers may rely on the guidance in the
temporary regulations (or on the existing proposed regulations) for
prior periods.
Summary
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 because of 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\ Under Secs. 1.125-1 and 1.125-2 of the existing proposed
regulations,\2\ an employee is permitted to make an election between
cash and qualified benefits before the beginning of the period of
coverage (which generally is the plan year of the cafeteria plan);
changes in the election during the plan year are permitted only in
limited circumstances.
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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
scholarships under section 117; educational assistance programs
under seciton 127; and fringe benefits under section 132.
\2\ Published as proposed rules at 49 FR 19321 (May 7, 1984) and
54 FR 9460 (March 7, 1989), respectively.
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The temporary 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. Proposed regulations are
also being published that cross-reference these temporary regulations,
and that replace the change in family status provisions in Q&A-6 of
proposed Sec. 1.125-2 with respect to accident or health plans and
group-term life insurance.
HIPAA Special Enrollment Rules
The temporary regulations conform the cafeteria plan rules to the
new special enrollment rights provided under HIPAA (which generally
require group health plans to permit individuals to be enrolled for
coverage following the loss of other health coverage, or if a person
becomes the spouse or dependent of an employee through birth, marriage,
adoption, or placement for adoption).\3\ Under the regulations, if an
employee has a right to enroll in an employer's group health plan or to
add coverage for a family member under HIPAA, the employee can make a
conforming election under the cafeteria plan. This allows required
contributions for such health coverage to be paid on a pre-tax basis.
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\3\ See section 9801(f). Similar provisions are set forth in
section 701(f) of the Employee Retirement Income Security Act of
1974 (ERISA), and section 2701(f) of the Public Health Service Act.
Regulations under these provisions are set forth in Treas. Reg.
Sec. 54.9801-6T; 29 C.F.R. Sec. 2590.701-6; and 45 C.F.R.
Sec. 146.117.
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Changes in Status
The temporary regulations include rules for other events, called
``changes in status,'' under which a cafeteria plan may allow an
employee to change his or
[[Page 60166]]
her election during the plan year. The events that constitute changes
in status under the regulations are changes in legal marital status,
number of dependents, employment status, work schedule, and residence
or worksite, and cases where the dependent satisfies or ceases to
satisfy the requirements for unmarried dependents.
The regulations permit a cafeteria plan to allow a change of
election during the plan year if a change in status occurs that affects
eligibility for coverage and the election change corresponds with the
effect on eligibility. For example, if under the terms of an accident
or health plan a child of an employee loses eligibility for coverage
upon graduation from college, the cafeteria plan may allow the employee
to cease payment for the child's coverage when the child graduates and
coverage ceases.
Certain of these changes in status (marriage, birth, adoption, and
placement for adoption) overlap with the special enrollment events
under HIPAA. The regulations include examples that clarify the
relationship between HIPAA's special enrollment rights and these change
in status rules. In addition, if a change in status occurs that
entitles an employee or family member to ``COBRA'' continuation
coverage (or coverage under a similar State program) with respect to
the employer's plan, the regulations permit payments for the
continuation coverage to be made on a pre-tax basis under a cafeteria
plan.
Other Events
The regulations allow a corresponding cafeteria plan change if a
plan receives a court order, such as a qualified medical child support
order under section 609 of ERISA. In addition, if an employee, spouse,
or dependent becomes entitled to Medicare or Medicaid, a cafeteria plan
can permit a corresponding election change.
Elective Contributions Under a Qualified Cash or Deferred Arrangement
The temporary regulations, in provisions similar to those of the
existing proposed regulations (proposed Sec. 1.125-2(f)), make clear
that the rules of section 401(k) and (m), rather than the rules in
these temporary regulations (which apply to other qualified benefits),
govern changes in elections under a qualified cash or deferred
arrangement (within the meaning of section 401(k)) or with respect to
employee after-tax contributions subject to section 401(m).
Scope of Temporary Regulations and Reliance on Proposed Regulations
The temporary regulations do not address certain provisions
concerning cafeteria plan election changes that are included in the
existing proposed regulations. Guidance on these provisions is reserved
at paragraphs (f)-(i) of the temporary regulations.
For example, future guidance under the significant cost change
provision (reserved at paragraph (g) of the temporary regulations),
rather than the change in status rules, would determine whether an
employee who switches from full-time to part-time employment and who
remains eligible under the employer's health plan could make an
election change if the part-time employee is required to pay
significantly higher amounts for the coverage. The temporary
regulations also reserve guidance with respect to provisions set forth
in the existing proposed regulations that permit an election change in
the case of a significant change in coverage (which includes a
significant change in the health coverage of the employee or spouse
attributable to the spouse's employment).\4\ Other matters not
addressed in the temporary regulations include the application of the
cafeteria plan election change rules to qualified benefits other than
accident or health coverage and group-term life insurance coverage (for
example, dependent care assistance programs), and special rules
concerning changes in elections by employees taking leave under the
Family and Medical Leave Act of 1993 (Pub. L. 103-3).\5\ Pending
further guidance, taxpayers can continue to rely on the existing
proposed regulations \6\ concerning these and other matters not
addressed in the temporary regulations.\7\
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\4\ See the second-to-last sentence in Q&A-6(c) of proposed
Sec. 1.125-2.
\5\ See Sec. 1.125.3, published as a proposed rule at 60 FR
66229 (December 21, 1995).
\6\ See also Sec. 1.125-2T, published at 51 FR 4312 (January 29,
1986), which describes benefits that may be offered under a
cafeteria plan.
\7\ See the preambles to proposed Secs. 1.125-1 and 1.125-2 and
Q&A-8 of proposed Sec. 1.125-3.
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The temporary regulations are effective for plan years beginning
after December 31, 1998. Prior to that date, however, taxpayers can
rely on the guidance provided in the temporary regulations (as well as
on the guidance provided in the existing proposed regulations that
relates to matters addressed in the temporary regulations) in order to
comply with the provisions of section 125.
Special Analyses
It has been determined that this Treasury Decision 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)
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
temporary 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 Catherine Fuller and
Sharon Cohen, 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 for part 1 continues to read in part as
follows:
Authority: 26 U.S.C. 7805 * * *
Par. 2. Sec. 1.125-4T is added to read as follows:
Sec. 1.125-4T Permitted election changes (temporary).
(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 (i) of this
section. See paragraph (j) of this section for special provisions
relating to qualified cash or deferred arrangements.
(b) Special enrollment rights. A cafeteria plan may permit an
employee to revoke an election for accident or health coverage during a
period of coverage and make a new election that corresponds with the
special enrollment rights provided in section 9801(f), whether or not
the change in election is permitted under paragraph (c) of this
section.
[[Page 60167]]
(c) Changes in status for accident or health coverage and group-
term life. (1) In general. A cafeteria plan may permit an employee to
revoke an election for accident or health coverage or group-term life
insurance coverage during a period of coverage and make a new election
for the remaining portion of the period if, under the facts and
circumstances --
(i) A change in status occurs; and
(ii) The election change satisfies the consistency requirement in
paragraph (c)(3) of this section (consistency rule for accident or
health coverage) or (c)(4) of this section (consistency rule for group-
term life insurance coverage).
(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 marriage, death of spouse, divorce, legal
separation, or annulment;
(ii) Number of dependents. Events that change an employee's number
of dependents (as defined in section 152), including birth, adoption,
placement for adoption (as defined in regulations under section 9801),
or death of a dependent;
(iii) Employment status. A termination or commencement of
employment by the employee, spouse, or dependent;
(iv) Work schedule. A reduction or increase in hours of employment
by the employee, spouse, or dependent, including a switch between part-
time and full-time, a strike or lockout, or commencement or return from
an unpaid leave of absence;
(v) Dependent satisfies or ceases to satisfy the requirements for
unmarried dependents. An event that causes an employee's dependent to
satisfy or cease to satisfy the requirements for coverage due to
attainment of age, student status, or any similar circumstance as
provided in the accident or health plan under which the employee
receives coverage; and
(vi) Residence or Worksite. A change in the place of residence or
work of the employee, spouse, or dependent.
(3) Consistency rule for accident or health coverage. (i) General
rule. (A) An employee's revocation of a cafeteria plan election during
a period of coverage and new election for the remaining portion of the
period (referred to below as an ``election change'') is consistent with
a change in status if, and only if--
(1) The change in status results in the employee, spouse, or
dependent gaining or losing eligibility for accident or health coverage
under either the cafeteria plan or an accident or health plan of the
spouse's or dependent's employer; and
(2) The election change corresponds with that gain or loss of
coverage.
(B) A change in status results in an employee, spouse, or dependent
gaining (or losing) eligibility for coverage under a plan only if the
individual becomes eligible (or ineligible) to participate in the plan.
A cafeteria plan may treat an individual as gaining (or losing)
eligibility for coverage if the individual becomes eligible (or
ineligible) for a particular benefit package option under a plan (e.g.,
a change in status results in an individual becoming eligible for a
managed care option or an indemnity option). If, as a result of a
change in status, the individual gains eligibility for elective
coverage under a plan of the spouse's or dependent's employer, the
consistency rule of this paragraph (c)(3)(i) is satisfied only if the
individual elects the coverage under the spouse's or dependent's
employer. See the Examples in paragraph (k) of this section for
illustrations of the consistency rule.
(ii) Exception for COBRA. Notwithstanding paragraph (c)(3)(i) of
this section, if the employee, spouse, or dependent becomes eligible
for continuation coverage under the employer's group health plan as
provided in section 4980B or any similar State law, the employee may
elect to increase payments under the employer's cafeteria plan in order
to pay for the continuation coverage.
(4) Consistency rule for group-term life insurance coverage. Except
as provided in this paragraph (c)(4), the provisions of paragraph
(c)(3)(i) of this section apply to group-term life insurance coverage.
In the case of marriage, birth, adoption, or placement for adoption, a
cafeteria plan can allow an election change to increase (but not to
reduce) the amount of the employee's life insurance coverage. In the
case of divorce, legal separation, annulment, or death of a spouse or
dependent, a cafeteria plan may allow an election change to reduce (but
not to increase) the amount of the employee's life insurance coverage.
(d) Judgment, decree, or order. 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 defined in section 609 of the
Employee Retirement Income Security Act of 1974) that requires accident
or health coverage for an employee's child. Notwithstanding the
provisions of paragraph (c) of this section, a cafeteria plan may--
(1) Change the employee's election to provide coverage for the
child if the order requires coverage under the employee's plan; or
(2) Permit the employee to make an election change to cancel
coverage for the child if the order requires the former spouse to
provide coverage.
(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., enrolled) under Part A or Part B of
Title XVIII of the Social Security Act (Medicare) or Title XIX of the
Social Security Act (Medicaid), 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 an election change to cancel coverage of that
employee, spouse or dependent under the accident or health plan.
(f) Changes in status for other qualified benefits. [Reserved].
(g) Significant coverage or cost changes. [Reserved].
(1) Employer's plan. [Reserved].
(2) Plan of spouse's or dependent's employer. [Reserved].
(h) Cessation of required contributions. [Reserved].
(i) Special requirements concerning the Family and Medical Leave
Act. [Reserved].
(j) 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
sections 401(k) and 401(m) and the regulations thereunder.
(k) Examples. The following examples illustrate the rules of this
section. In each case involving an accident or health plan, assume that
the plan is subject to section 9801(f) (providing for special
enrollment rights under certain group health plans).
Example 1. (i) Employer M provides health coverage for its
employees under which 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,
elects employee-only health coverage before the beginning of the
calendar year. During the year, A adopts
[[Page 60168]]
a child, C. Within 30 days thereafter, A wants to revoke A's
election for employee-only health coverage and obtain family health
coverage, as of the date of C's adoption. 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 for C,
effective as of the date of C's adoption.
(ii) In this Example 1, M's cafeteria plan may permit A to
change the employee's salary reduction election to family coverage
for salary not yet currently available. The increased salary
reduction could reflect the cost of family coverage from the date of
adoption. (The adoption of C is also a change in status, and the
election of family coverage is consistent with that change in
status. Thus, under the change in status provisions of paragraph (c)
of this section, M's cafeteria plan could permit A to elect family
coverage prospectively in order to cover C for the remaining portion
of the coverage period.)
Example 2. (i) The employer plans and permissible coverage are
the same as in Example 1. Before the beginning of the calendar year,
Employee A elects employee-only health coverage under M's cafeteria
plan. A marries B during the plan year. B's employer, N, offers
health coverage to N's employees, and, prior to the marriage, B had
elected employee-only coverage. 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) In this Example 2, A's marriage to B is a change in status.
Two possible election changes by A would be consistent with the
change in status: to cover A and B by electing family health
coverage under M's plan, or to cancel coverage under M's plan (with
B electing family health coverage under N's plan in order to cover A
and B). Thus, M's cafeteria plan may permit A to make either change
in election. (M's cafeteria plan could also permit A to change A's
salary reduction election to reflect the change to family coverage
under M's group health plan in accordance with paragraph (b) of this
section because the marriage would also create special enrollment
rights under section 9801(f), pursuant to which an election of
family coverage under M's 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.)
Example 3. (i) Employee G, a single parent, elects family health
coverage under a calendar year cafeteria plan maintained by Employer
O. G and G's 21-year old child, H, are covered under O's health
plan. During the year, H graduates from college. Under the terms of
the health plan, dependents over the age of 19 must be full-time
students to receive coverage. G wants to revoke G's election for
family health coverage and obtain employee-only coverage under O's
cafeteria plan.
(ii) In this Example 3, H's loss of eligibility for coverage
under the terms of the health plan is a change in status. A
revocation of G's election for family coverage and new election of
employee-only coverage is consistent with the change in status.
Thus, O's cafeteria plan may permit G to elect employee-only
coverage.
Example 4. (i) Employee J is married to K and they have one
child, S. A calendar year cafeteria plan maintained by Employer P
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, J elects
family health coverage for J, K, and S. J and K divorce during the
year and, under the terms of P's accident or health plan, K loses
eligibility for P's health coverage. S does not lose eligibility for
health coverage under P's plan upon the divorce. J now wants to
revoke J's election under the cafeteria plan and elect no coverage.
(ii) In this Example 4, the divorce is a change in status. A
change in the cafeteria plan election to cancel health coverage for
K is consistent with that change in status. However, the divorce
does not affect J's or S's eligibility for health coverage.
Therefore, an election change to cancel J's or S's health coverage
is not consistent with the change in status. The cafeteria plan,
however, may permit J to elect employee-plus-one-dependent health
coverage.
Example 5. (i) The facts are the same as Example 4, except that,
before the beginning of the year, Employee J elected employee-only
health coverage (rather than family coverage). Pursuant to J s
divorce agreement with K, P s health plan receives a qualified
medical child support order (as defined in section 609 of the
Employee Retirement Income Security Act) during the plan year. The
order requires P s health plan to cover S.
(ii) In this Example 5, P's cafeteria plan may change J's
election from employee-only health coverage to employee-plus-one-
dependent coverage in order to cover S.
Example 6. (i) Before the beginning of the coverage period,
Employee L elects to participate in a cafeteria plan maintained by
L's Employer, Q. However, in order to change the election during the
coverage period so as to cancel coverage, and by prior understanding
with Q, L terminates employment and resumes employment one week
later.
(ii) In this Example 6, under the facts and circumstances, in
which a principal purpose of the termination of employment was to
alter the election and reinstatement of employment was understood at
the time of termination, L does not have a change in status.
However, L's termination of employment would constitute a change in
status, permitting a cancellation of coverage during the period of
unemployment, if L s original cafeteria plan election was reinstated
upon resumption of employment (for example, because of a cafeteria
plan 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).
Example 7. (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
that work in the respective service areas of the two HMOs. Employee
T, who works in the service area of HMO #1, elects the HMO #1
option. During the year, T is transferred to another work location
which is outside the HMO #1 service area and inside the HMO #2
service area.
(ii) In this Example 7, the transfer is a change in status and,
under the consistency rule, the cafeteria plan may permit T to make
an election change to either the indemnity option or HMO #2, or to
cancel accident or health coverage.
Example 8. (i) A calendar year cafeteria plan maintained by
Employer S allows employees to elect coverage under an accident or
health plan providing indemnity coverage and under a flexible
spending arrangement (FSA). Prior to the beginning of the calendar
year, Employee U elects employee-only indemnity coverage, and
coverage under the FSA for up to $600 of reimbursements for the year
to be funded by salary reduction contributions of $600 during the
year. U's spouse, V, has employee-only coverage under an accident or
health plan maintained by V's employer. During the year, V
terminates employment and loses coverage under that plan. U now
wants to elect family coverage under S's accident or health plan and
increase U's FSA election.
(ii) In this Example 8, V's termination of employment is a
change in status. The cafeteria plan may permit U to elect family
coverage under S's accident or health plan, and to increase U's FSA
coverage.
Example 9. (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 the lesser of
his or her salary or $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.
Before the beginning of the calendar year, Employee W elects $10,000
of life insurance coverage, with W s spouse, X, as the beneficiary.
During the year, a child is placed for adoption with W and X. W
wants to increase W's election for life insurance coverage to
$50,000 (without changing the designation of X as the beneficiary).
(ii) In this Example 9, the placement of a child for adoption
with W is a change in status. The increase in coverage is consistent
with the change in status. Thus, W's cafeteria plan may permit W to
increase W's life insurance coverage.
(1) Effective Date. This section is effective for plan years
beginning after December 31, 1998.
Michael P. Dolan,
Acting Commissioner of Internal Revenue.
Dated: October 10, 1997.
Donald C. Lubick,
Acting Assistant Secretary of the Treasury.
[FR Doc. 97-29087 Filed 11-6-97; 8:45 am]
BILLING CODE 4830-01-U