[Federal Register Volume 65, Number 57 (Thursday, March 23, 2000)]
[Rules and Regulations]
[Pages 15548-15553]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-5817]



[[Page 15548]]

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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 8878]
RIN 1545-AU61


Tax Treatment of Cafeteria Plans

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document contains final regulations relating to section 
125 cafeteria plans. The final regulations clarify the circumstances 
under which a section 125 cafeteria plan election may be changed. The 
final regulations permit an employer to allow a section 125 cafeteria 
plan participant to revoke an existing election and make a new election 
during a period of coverage for accident or health coverage or group-
term life insurance coverage.

DATES: Effective Date: These regulations are effective March 23, 2000.
    Applicability Date: These regulations are applicable for cafeteria 
plan years beginning on or after January 1, 2001. See the Scope of 
Regulations and Effective Date portion of this preamble.

FOR FURTHER INFORMATION CONTACT: Janet A. Laufer or Christine L. Keller 
at (202) 622-6080 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

    This document contains amendments to the Income Tax Regulations (26 
CFR part 1) under section 125. Section 125 generally provides that an 
employee in a cafeteria plan will not have an amount included in gross 
income solely because the employee may choose among two or more 
benefits consisting of cash and ``qualified benefits.'' A qualified 
benefit generally is any benefit that is excludable from gross income 
under an express provision of the Internal Revenue Code, including 
coverage under an employer-provided accident or health plan under 
sections 105 and 106, group-term life insurance under section 79, 
elective contributions under a qualified cash or deferred arrangement 
within the meaning of section 401(k), dependent care assistance under 
section 129, and adoption assistance under section 137.\1\ Qualified 
benefits can be provided under a cafeteria plan either through insured 
arrangements or arrangements that are not insured.
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    \1\ The following are not qualified benefits: products 
advertised, marketed, or offered as long-term care insurance; 
medical savings accounts under section 106(b); qualified scholarshps 
under section 117; educational assistance programs under section 
127; and fringe benefits under section 132.
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    In 1984 and 1989, proposed regulations were published relating to 
the administration of cafeteria plans.\2\ In general, the 1984 and 1989 
proposed regulations require that for benefits to be provided on a pre-
tax basis under section 125, an employee may make changes during a plan 
year only in certain circumstances.\3\ Specifically, Q&A-8 of 
Sec. 1.125-1 and Q&A-6(b), (c), and (d) of Sec. 1.125-2 permit 
participants to make benefit election changes during a plan year 
pursuant to changes in cost or coverage, changes in family status, and 
separation from service.
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    \2\ 49 FR 19321 (May 7, 1984) and 54 FR 9460 (March 7, 1989), 
respectively.
    \3\ Those proposed regulations contain special rules with 
respect to flexible spending arrangements. A flexible spending 
arrangement (FSA) is defined in section 106(c)(2). Under section 
106(c)(2), an FSA is generally a benefit program under which the 
maximum reimbursement reasonably available for coverage is less than 
500% of the value of the coverage.
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    In 1997, temporary and proposed regulations were issued addressing 
the standards under which a cafeteria plan may permit a participant to 
change his or her group health coverage election during a period of 
coverage to conform with the special enrollment rights under section 
9801(f) (added to the Internal Revenue Code by the Health Insurance 
Portability and Accountability Act of 1996 (HIPAA)) and to change his 
or her group health or group-term life insurance coverage in a variety 
of change in status situations.\4\
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    \4\ 62 FR 60196 (November 7, 1997) and 62 FR 60165 (November 7, 
1997), respectively. IRS Announcement 98-105 (1998-49 I.R.B. 21 
(November 23, 1998)) states that the Service will amend the 
effective date of those proposed and temporary regulations so that 
they will not be effective before plan years beginning at least 120 
days after further guidance is issued.
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    These final regulations, which replace the 1997 temporary 
regulations, clarify the circumstances under which a cafeteria plan may 
permit an employee to revoke an existing election with respect to 
accident or health coverage, or group-term life insurance coverage, and 
make a new election during a period of coverage.

Explanation of Provisions

A. Summary

    These regulations clarify the circumstances under which a cafeteria 
plan may permit an employee to change his or her cafeteria plan 
election with respect to accident or health coverage or group-term life 
insurance coverage during the plan year. The regulations generally 
follow the existing temporary regulations, and include a variety of 
examples illustrating how the rules apply in specific situations.
    The final regulations include two principal changes that have been 
made in response to public comments. First, the regulations differ from 
the 1997 regulations with respect to change in status events resulting 
from a change in employment. Commentators requested a loosening of the 
rules regarding when a cafeteria plan election can be changed. In 
response, the final rules incorporate a more flexible rule under which 
any change in the employment status of the employee (or a spouse or 
dependent of the employee) that affects that individual's eligibility 
under a cafeteria plan or qualified benefits plan constitutes a change 
in status for purposes of permitting a mid-year election change. 
Second, in the event of a change in an employee's marital status or the 
employment status of the employee's spouse or dependent, the final 
regulations permit the employee to elect either to increase group-term 
life insurance coverage or to decrease group-term life insurance 
coverage. A similar rule applies with respect to disability income 
plans.
    These final regulations were developed as part of an integrated 
package with proposed regulations that are being published elsewhere in 
this issue of the Federal Register. Those proposed regulations provide 
guidance on election changes on account of changes in status with 
respect to dependent care assistance and adoption assistance and 
provide guidance on election changes on account of changes in cost or 
coverage with respect to dependent care assistance, adoption 
assistance, accident or health coverage, and group-term life insurance 
coverage. The integrated package of final and proposed regulations is 
intended to provide clear standards for plan administration and for 
administration of the tax law. The standards are designed to 
accommodate the most common types of events of independent significance 
that do not occur on a regular, periodic basis and that are likely to 
affect an employee's decisions with respect to qualified benefits 
coverage.

B. Changes in Status

    Commentators on the 1997 temporary and proposed regulations 
requested that the description of changes in status be expanded to 
include work-related changes of an employee, the employee's spouse, or 
the employee's dependent in addition to termination or commencement of 
employment or change in worksite. In response to these comments, the 
description of changes in

[[Page 15549]]

status has been broadened to include a strike or lockout, and a 
commencement of or return from an unpaid leave of absence. In addition, 
the final rules incorporate a more flexible rule for other change in 
employment status events. Specifically, if there is a change in the 
employment status of the employee (or a spouse or dependent of the 
employee) that affects that individual's eligibility under a cafeteria 
plan or qualified benefits plan, then that change constitutes a change 
in status. For example, if an employee switches from salaried to 
hourly-paid status, resulting in the employee ceasing to be eligible 
for coverage under the plan, then that change constitutes a change in 
status.
    Some commentators expressed concern that the 1997 temporary and 
proposed regulations did not permit an employee to make an election 
change to cover additional individuals under an accident or health plan 
when an employer changed its policy (e.g., to permit coverage for a 
parent or for a domestic partner pursuant to local law requirements). 
Under the 1997 temporary and proposed regulations, a change in status 
includes an event that causes an employee's dependent to satisfy or 
cease to satisfy the eligibility requirements for coverage under a 
plan. Thus, if an individual who is a dependent of an employee becomes 
eligible for coverage under the employer's health plan as a result of 
an amendment made to the plan during the year, that is a change in 
status event and, accordingly, the cafeteria plan may permit an 
election change by the employee to cover the individual. These final 
regulations retain the rule from the 1997 temporary and proposed 
regulations.
    These final regulations do not address when a bona fide termination 
of employment occurs. However, these regulations retain the example 
(Example 8 under paragraph (c)(4) of these final regulations) from the 
1997 temporary and proposed regulations addressing the situation in 
which an employee terminates and resumes employment within 30 days. The 
effect of this example is to provide a practical safe harbor that 
generally may be applied by cafeteria plans without regard to other 
facts and circumstances. Under this example, if an employee terminates 
and resumes employment within 30 days and the cafeteria plan provides 
that the employee's election is automatically reinstated, the employer 
is not required to determine whether a bona fide change in status has 
occurred with respect to termination of employment. Conversely, the 
cafeteria plan may permit an employee who resumes employment more than 
30 days following termination to be automatically reinstated to the 
prior election or to make a new election.\5\
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    \5\ Alternatively, the cafeteria plan may prohibit an employee 
from participating in the cafeteria plan for that plan year upon 
reemployment.
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C. Consistency Rule

    As under the 1997 temporary and proposed regulations, the final 
regulations require that an election change as a result of a change in 
status also satisfy a consistency requirement. In response to comments, 
the final regulations expand and clarify the consistency requirement 
with respect to change in status events for group-term life insurance. 
Under the 1997 regulations, in the case of a commencement of 
employment, marriage, birth, adoption, or placement for adoption, an 
employee could elect to increase (but not decrease) group-term life 
insurance coverage. The 1997 regulations also permitted an employee to 
elect to decrease (but not to increase) group-term life insurance 
coverage in the case of divorce, legal separation, annulment, or death 
of a spouse or dependent. Commentators suggested that these rules were 
too restrictive. For example, in the case of divorce, an employee may 
reasonably seek to increase coverage because the employee may become 
the sole wage-earner for the family unit as a result of the divorce. 
Accordingly, the final regulations provide flexibility by stating that, 
in the event of a change in an employee's marital status or the 
employment status of the employee's spouse or dependent, an employee 
may elect either to increase group-term life insurance coverage or to 
decrease group-term life insurance coverage. Also, in response to 
comments, a similar rule has been added that applies to election 
changes made with respect to disability income coverage (i.e., accident 
or health coverage that is neither for medical care as defined under 
section 213(d) nor for payments described in section 105(c)).

D. Other Changes

    Some commentators requested that the regulations prescribe a period 
of time by which election changes, as a result of a change in status, 
should be made. Consistent with the approach taken in the 1997 
regulations and in the interest of providing employers and plan 
administrators flexibility, the final regulations do not prescribe such 
a period. However, nothing in the final regulations would prevent a 
cafeteria plan by its terms from requiring that any election change 
(other than those made in connection with rights for which there are 
specific minimum election periods, such as under section 9801 (as added 
by HIPAA) and section 4980B (relating to COBRA coverage)), must be made 
within a specified period after a change in status event. The 
consistency rule in the final regulations does require that an election 
change made pursuant to a change in status be ``on account of'' a gain 
or loss of eligibility for coverage. This requirement follows the ``on 
account of'' language contained in the 1989 proposed regulations under 
Sec. 1.125-2, Q&A-6(c), and is intended to add a general condition that 
the election change not be made so long after the event permitting the 
election change that the election is not on account of the event.
    In accordance with comments, examples in the regulations clarify 
that if, in accordance with special enrollment rights provided by HIPAA 
, an employee, spouse, or new dependent is entitled to enroll in a 
group health plan, a cafeteria plan may permit the employee to elect to 
enroll pre-existing dependents in the underlying group health plan.\6\ 
Likewise, the examples clarify that if, in accordance with the change 
in status rules relating to a new spouse or dependent, an employee is 
entitled to elect family coverage under a group health plan, then other 
family members are permitted to become covered under the family 
coverage as a result of the election change.\7\
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    \6\ No inference is intended from these or any other examples in 
the final regulations concerning the interpretation of special 
enrollment rights under section 9801(f).
    \7\ Provisions in paragraph (b) of the final regulation allowing 
election changes in connection with special enrollment under section 
9801(f) may overlap the provisions in paragraphs (c) through (e) of 
the final regulations permitting election changes in other 
circumstances. Thus, no inference is intended that an election 
change permitted under paragraphs (c) through (e) is not also 
permitted under paragraph (b).
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    In response to comments, the final regulations also clarify that, 
in the event of a loss of Medicare or Medicaid entitlement by an 
employee or by the employee's spouse or dependent, a cafeteria plan may 
permit the employee to add health coverage under the employer's 
accident or health plan (and may permit cancellation or reduction in 
coverage if an employee, spouse, or dependent who is enrolled in an 
accident or health plan becomes entitled to Medicare or Medicaid).

Scope of Regulations and Effective Date

    These final regulations address all of the changes in status for 
which a cafeteria plan may permit election

[[Page 15550]]

changes with respect to an accident or health plan or group-term life 
insurance plan. However, future guidance under the cost or coverage 
change provision (reserved at paragraph (f) of these final regulations 
and included in paragraph (f) of the proposed regulations being 
published elsewhere in this issue of the Federal Register), rather than 
the change in status rules, would determine whether a cafeteria plan 
may permit affected employees to elect a new HMO option that is made 
available during a period of coverage. Similarly, election changes may 
be made under the special rules relating to changes in elections by 
employees taking leave under the Family and Medical Leave Act of 1993 
(Public Law 103-3) \8\ (as referenced at paragraph (g) of these final 
regulations).
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    \8\ See Sec. 1.125.3, published as a proposed rule at 60 FR 
(December 21, 1995).
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    Finally, these regulations do not override other cafeteria plan 
requirements. For example, although an employee's termination of 
employment is a change in status, some election changes made with 
respect to coverage under a health FSA on account of the termination of 
employment would fail to be consistent with the requirement that the 
operation of such arrangements exhibit the risk-shifting and risk-
distribution characteristics of insurance under Sec. 1.125-1, Q&A-17 
and Sec. 1.125-2, Q&A-7 of the proposed regulations. Thus, a cafeteria 
plan could not permit individuals terminating employment to change 
their health FSA elections to match the amount of premiums paid prior 
to termination (i.e., stop paying premiums), and continue to receive 
health FSA reimbursements with respect to the remainder of the period 
of coverage.
    These regulations are applicable for cafeteria plan years beginning 
on or after January 1, 2001. Until the beginning of the first plan year 
beginning on or after January 1, 2001, taxpayers may rely on these 
regulations. In addition, until the beginning of the first plan year 
beginning on or after January 1, 2001, taxpayers may continue to rely 
on the change in status rules in the 1997 regulations, as well as the 
change in family status rules in the pre-1997 proposed regulations.
    Pursuant to section 7805(e), the 1997 temporary regulations 
Sec. 1.125-4T will expire within three years of the date of issuance 
(November 7, 2000). This Treasury decision amends the 1997 temporary 
regulations to add this expiration in the text of the regulations 
(Sec. 1.125-4T(l)).

Special Analyses

    It has been determined that this Treasury decision is not a 
significant regulatory action as defined in Executive Order 12866. 
Therefore, a regulatory assessment is not required. It also has been 
determined that section 553(b) of the Administrative Procedure Act (5 
U.S.C. chapter 5) does not apply to these regulations, and because the 
regulation does not impose a collection of information on small 
entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not 
apply. Pursuant to section 7805(f) of the Internal Revenue Code, these 
regulations will be submitted to the Chief Counsel for Advocacy of the 
Small Business Administration for comment on its impact on small 
business.

    Drafting Information: The principal authors of these regulations 
are Janet A. Laufer and Christine L. Keller, Office of the Associate 
Chief Counsel (Employee Benefits and Exempt Organizations). However, 
other personnel from the IRS and Treasury Department participated in 
their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

    Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAXES

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

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

    Par. 2. Sec. 1.125-4 is added to read as follows:


Sec. 1.125-4  Permitted election changes.

    (a) Election changes. A cafeteria plan may permit an employee to 
revoke an election during a period of coverage and to make a new 
election only as provided in paragraphs (b) through (g) of this 
section. Section 125 does not require a cafeteria plan to permit any of 
these changes. See paragraph (h) of this section for special provisions 
relating to qualified cash or deferred arrangements, and paragraph (i) 
of this section for special definitions used in this section.
    (b) Special enrollment rights--(1) In general. A cafeteria plan may 
permit an employee to revoke an election for coverage under a group 
health plan during a period of coverage and make a new election that 
corresponds with the special enrollment rights provided in section 
9801(f).
    (2) Examples. The following examples illustrate the application of 
this paragraph (b):

    Example 1. (i) Employer M provides health coverage for its 
employees pursuant to a plan that is subject to section 9801(f). 
Under the plan, employees may elect either employee-only coverage or 
family coverage. M also maintains a calendar year cafeteria plan 
under which qualified benefits, including health coverage, are 
funded through salary reduction. M's employee, A, is married to B 
and they have a child, C. In accordance with M's cafeteria plan, 
Employee A elects employee-only health coverage before the beginning 
of the calendar year. During the year, A and B adopt a child, D. 
Within 30 days thereafter, A wants to revoke A's election for 
employee-only health coverage and obtain family health coverage for 
A's spouse, C, and D as of the date of D's adoption. Employee A 
satisfies the conditions for special enrollment of an employee with 
a new dependent under section 9801(f)(2), so that A may enroll in 
family coverage under M's accident or health plan in order to 
provide coverage effective as of the date of D's adoption.
    (ii) M's cafeteria plan may permit A to change A's salary 
reduction election to family coverage for salary not yet currently 
available. The increased salary reduction is permitted to reflect 
the cost of family coverage from the date of adoption. (A's adoption 
of D is also a change in status, and the election of family coverage 
is consistent with that change in status. Thus, under paragraph (c) 
of this section, M's cafeteria plan could permit A to elect family 
coverage prospectively in order to cover B, C, and D for the 
remaining portion of the period of coverage.)
    Example 2. (i) The employer plans and permissible coverage are 
the same as in Example 1. Before the beginning of the calendar year, 
Employee E elects employee-only health coverage under M's cafeteria 
plan. Employee E marries F during the plan year. F's employer, N, 
offers health coverage to N's employees, and, prior to the marriage, 
F had elected employee-only coverage. Employee E wants to revoke the 
election for employee-only coverage under M's cafeteria plan, and is 
considering electing family health coverage under M's plan or 
obtaining family health coverage under N's plan.
    (ii) M's cafeteria plan may permit E to change E's salary 
reduction election to reflect the change to family coverage under 
M's group health plan because the marriage would result in special 
enrollment rights under section 9801(f), pursuant to which an 
election of family coverage under M's group health plan would be 
required to be effective no later than the first day of the first 
calendar month beginning after the completed request for enrollment 
is received by the plan. (E's marriage to F is also a change in 
status under paragraph (c) of this section, as illustrated in 
Example 1 of paragraph (c)(4) of this section.)

    (c) Changes in status--(1) In general--(i) Change in status rule. A 
cafeteria plan may permit an employee to revoke an election during a 
period of coverage with respect to a qualified benefits plan

[[Page 15551]]

to which this paragraph (c) applies and make a new election for the 
remaining portion of the period (referred to in this section as an 
election change) if, under the facts and circumstances--
    (A) A change in status described in paragraph (c)(2) of this 
section occurs; and
    (B) The election change satisfies the consistency rule of paragraph 
(c)(3) of this section.
    (ii) Application to accident or health plans and group-term life 
insurance plans. This paragraph (c) applies to plans providing accident 
or health coverage and plans providing group-term life insurance 
coverage.
    (iii) Application to other qualified benefits. [Reserved]
    (2) Change in status events. The following events are changes in 
status for purposes of this paragraph (c):
    (i) Legal marital status. Events that change an employee's legal 
marital status, including the following: marriage; death of spouse; 
divorce; legal separation; and annulment.
    (ii) Number of dependents. Events that change an employee's number 
of dependents, including the following: birth; death; adoption; and 
placement for adoption.
    (iii) Employment status. Any of the following events that change 
the employment status of the employee, the employee's spouse, or the 
employee's dependent: a termination or commencement of employment; a 
strike or lockout; a commencement of or return from an unpaid leave of 
absence; and a change in worksite. In addition, if the eligibility 
conditions of the cafeteria plan or other employee benefit plan of the 
employer of the employee, spouse, or dependent depend on the employment 
status of that individual and there is a change in that individual's 
employment status with the consequence that the individual becomes (or 
ceases to be) eligible under the plan, then that change constitutes a 
change in employment under this paragraph (c) (e.g., if a plan only 
applies to salaried employees and an employee switches from salaried to 
hourly-paid with the consequence that the employee ceases to be 
eligible for the plan, then that change constitutes a change in 
employment status under this paragraph (c)(2)(iii)).
    (iv) Dependent satisfies or ceases to satisfy eligibility 
requirements. Events that cause an employee's dependent to satisfy or 
cease to satisfy eligibility requirements for coverage on account of 
attainment of age, student status, or any similar circumstance.
    (v) Residence. A change in the place of residence of the employee, 
spouse, or dependent.
    (3) Consistency rule--(i) Application to accident or health 
coverage and group-term life insurance. An election change satisfies 
the requirements of this paragraph (c)(3) with respect to accident or 
health coverage or group-term life insurance only if the election 
change is on account of and corresponds with a change in status that 
affects eligibility for coverage under an employer's plan.
    (ii) Application to other qualified benefits. [Reserved]
    (iii) Application of consistency rule. If the change in status is 
the employee's divorce, annulment or legal separation from a spouse, 
the death of a spouse or dependent, or a dependent ceasing to satisfy 
the eligibility requirements for coverage, an employee's election under 
the cafeteria plan to cancel accident or health insurance coverage for 
any individual other than the spouse involved in the divorce, annulment 
or legal separation, the deceased spouse or dependent, or the dependent 
that ceased to satisfy the eligibility requirements for coverage, 
respectively, fails to correspond with that change in status. Thus, if 
a dependent dies or ceases to satisfy the eligibility requirements for 
coverage, the employee's election to cancel accident or health coverage 
for any other dependent, for the employee, or for the employee's spouse 
fails to correspond with that change in status. In addition, if an 
employee, spouse, or dependent gains eligibility for coverage under a 
family member plan (as defined in paragraph (i)(5) of this section) as 
a result of a change in marital status under paragraph (c)(2)(i) of 
this section or a change in employment status under paragraph 
(c)(2)(iii) of this section, an employee's election under the cafeteria 
plan to cease or decrease coverage for that individual under the 
cafeteria plan corresponds with that change in status only if coverage 
for that individual becomes applicable or is increased under the family 
member plan. However, if the change in status is a change in the 
employee's marital status under paragraph (c)(2)(i) of this section or 
a change in the employment status of the employee's spouse or 
dependents under paragraph (c)(2)(iii) of this section, an election to 
increase, or an election to decrease, group-term life insurance or 
disability income coverage corresponds with that change in status.
    (iv) Exception for COBRA. If the employee, spouse, or dependent 
becomes eligible for continuation coverage under the group health plan 
of the employee's employer as provided in section 4980B or any similar 
state law, a cafeteria plan may permit the employee to elect to 
increase payments under the employer's cafeteria plan in order to pay 
for the continuation coverage.
    (4) Examples. The following examples illustrate the application of 
this paragraph (c):

    Example 1. (i) Employer M provides health coverage (including a 
health FSA) for its employees through its cafeteria plan. Before the 
beginning of the calendar year, Employee A elects employee-only 
health coverage under M's cafeteria plan and elects salary reduction 
contributions to fund coverage under the health FSA. Employee A 
marries B during the year. Employee B's employer, N, offers health 
coverage to N's employees (but not including any health FSA), and, 
prior to the marriage, B had elected employee-only coverage. 
Employee A wants to revoke the election for employee-only coverage, 
and is considering electing family health coverage under M's plan or 
obtaining family health coverage under N's plan.
    (ii) Employee A's marriage to B is a change in status under 
paragraph (c)(2)(i) of this section, pursuant to which B has become 
eligible for coverage under M's health plan under paragraph 
(c)(3)(i) of this section. Two possible election changes by A 
correspond with the change in status: Employee A may elect family 
health coverage under M's plan to cover A and B; or A may cancel 
coverage under M's plan, if B elects family health coverage under 
N's plan to cover A and B. Thus, M's cafeteria plan may permit A to 
make either election change.
    (iii) Employee A may also increase salary reduction 
contributions to fund coverage for B under the health FSA.
    Example 2. (i) Employee C, a single parent, elects family health 
coverage under a calendar year cafeteria plan maintained by Employer 
O. Employee C and C's 21-year old child, D, are covered under O's 
health plan. During the year, D graduates from college. Under the 
terms of the health plan, dependents over the age of 19 must be 
full-time students to receive coverage. Employee C wants to revoke 
C's election for family health coverage and obtain employee-only 
coverage under O's cafeteria plan.
    (ii) D's loss of eligibility for coverage under the terms of the 
health plan is a change in status under paragraph (c)(2)(iv) of this 
section. A revocation of C's election for family coverage and new 
election for employee-only coverage corresponds with the change in 
status. Thus, O's cafeteria plan may permit C to elect employee-only 
coverage.
    Example 3. (i) Employee E is married to F and they have one 
child, G. Employee E is employed by Employer P, and P maintains a 
calendar year cafeteria plan that allows employees to elect no 
health coverage, employee-only coverage, employee-plus-one-dependent 
coverage, or family coverage. Under the plan, before the beginning 
of the calendar year, E elects family health coverage for E, F, and 
G. E and F divorce during the year and F loses eligibility for 
coverage under P's plan. G does not lose eligibility for health 
coverage under P's plan upon the divorce. E

[[Page 15552]]

now wants to revoke E's election under the cafeteria plan and elect 
no coverage.
    (ii) The divorce is a change in status under paragraph 
(c)(2)(i). A change in the cafeteria plan election to cancel health 
coverage for F is consistent with that change in status. However, an 
election change to cancel E's or G's health coverage does not 
satisfy the consistency rule under paragraph (c)(3)(iii) of this 
section regarding cancellation of coverage for an employee's other 
dependents in the event of divorce. Therefore, the cafeteria plan 
may not permit E to elect no coverage. However, an election to 
change to employee-plus-one-dependent health coverage would 
correspond with the change in status, and thus the cafeteria plan 
may permit E to elect employee-plus-one-dependent health coverage.
    Example 4. (i) Employer R maintains a calendar year cafeteria 
plan under which full-time employees may elect coverage under one of 
three benefit package options provided under an accident or health 
plan: an indemnity option or either of two HMO options for employees 
who work in the respective service areas of the two HMOs. Employee 
A, who works in the service area of HMO #1, elects the HMO #1 
option. During the year, A is transferred to another work location 
which is outside the HMO #1 service area and inside the HMO #2 
service area.
    (ii) The transfer is a change in status under paragraph 
(c)(2)(iii) of this section (relating to a change in worksite), and, 
under the consistency rule in paragraph (c)(3) of this section, the 
cafeteria plan may permit A to make an election change to either the 
indemnity option or HMO #2.
    Example 5. (i) Employer S maintains a calendar year cafeteria 
plan that allows employees to elect coverage under an accident or 
health plan providing indemnity coverage and coverage under a health 
FSA. Prior to the beginning of the calendar year, Employee B elects 
employee-only indemnity coverage, and elects salary reduction 
contributions of $600 during the year to fund coverage under the 
health FSA for up to $600 of reimbursements for the year. Employee 
B's spouse, C, has employee-only coverage under an accident or 
health plan maintained by C's employer. During the year, C 
terminates employment and loses coverage under that plan. B now 
wants to elect family coverage under S's accident or health plan and 
increase B's FSA election.
    (ii) C's termination of employment is a change in status under 
paragraph (c)(2)(iii) of this section, and the election change 
satisfies the consistency rule of paragraph (c)(3) of this section. 
Therefore, the cafeteria plan may permit B to elect family coverage 
under S's accident or health plan and to increase B's FSA coverage.
    Example 6. (i) Employer T provides group-term life insurance 
coverage as described under section 79. Under T's plan, an employee 
may elect life insurance coverage in an amount up to $50,000. T also 
maintains a calendar year cafeteria plan under which qualified 
benefits, including the group-term life insurance coverage, are 
funded through salary reduction. Employee D has a spouse and a 
child. Before the beginning of the year, D elects $10,000 of group-
term life insurance coverage. During the year, D is divorced.
    (ii) The divorce is a change in status under paragraph (c)(2)(i) 
of this section. Under paragraph (c)(3)(iii) of this section, either 
an increase or a decrease in coverage is consistent with this change 
in status. Thus, T's cafeteria plan may permit D to increase or to 
decrease D's group-term life insurance coverage.
    Example 7. (i) Employee E is married to F and they have one 
child, G. Employee E's employer, U, maintains a cafeteria plan under 
which employees may elect no coverage, employee-only coverage, or 
family coverage under a group health plan maintained by U, and may 
make a separate vision coverage election under the plan. Before the 
beginning of the calendar year, E elects family health coverage and 
no vision coverage under U's cafeteria plan. Employee F's employer, 
V, maintains a cafeteria plan under which employees may elect no 
coverage, employee-only coverage, or family coverage under a group 
health plan maintained by V, and may make a separate vision coverage 
election under the plan. Before the beginning of the calendar year, 
F elects no health coverage and employee-only vision coverage under 
V's plan. During the year, F terminates employment with V and loses 
vision coverage under V's plan. Employee E now wants to elect family 
vision coverage under U's group health plan.
    (ii) F's termination of employment is a change in status under 
paragraph (c)(2)(iii) of this section, and the election change 
satisfies the consistency rule of paragraph (c)(3) of this section. 
Therefore, U's cafeteria plan may permit E to elect family vision 
coverage (covering E and G as well as F) under U's group health 
plan.
    Example 8. (i) Before the beginning of the year, Employee H 
elects to participate in a cafeteria plan maintained by H's 
employer, W. However, in order to change the election during the 
year so as to cancel coverage, and by prior understanding with W, H 
terminates employment and resumes employment one week later.
    (ii) In this Example 8, under the facts and circumstances, a 
principal purpose of the termination of employment was to alter the 
election, and reinstatement of employment was understood at the time 
of termination. Accordingly, H does not have a change in status 
under paragraph (c)(2)(iii) of this section.
    (iii) However, H's termination of employment would constitute a 
change in status, permitting a cancellation of coverage during the 
period of unemployment, if H's original cafeteria plan election for 
the period of coverage was reinstated upon resumption of employment 
(for example, if W's cafeteria plan contains a provision requiring 
an employee who resumes employment within 30 days, without any other 
intervening event that would permit a change in election, to return 
to the election in effect prior to termination of employment).
    (iv) If, instead, H terminates employment and cancels coverage 
during a period of unemployment, and then returns to work more than 
30 days following termination of employment, the cafeteria plan may 
permit H the option of returning to the election in effect prior to 
termination of employment or making a new election under the plan. 
Alternatively, the cafeteria plan may prohibit H from returning to 
the plan during that plan year.

    (d) Judgment, decree, or order--(1) Conforming election change. 
This paragraph (d) applies to a judgment, decree, or order (order) 
resulting from a divorce, legal separation, annulment, or change in 
legal custody (including a qualified medical child support order as 
defined in section 609 of the Employee Retirement Income Security Act 
of 1974 (Public Law 93-406 (88 Stat. 829))) that requires accident or 
health coverage for an employee's child or for a foster child who is a 
dependent of the employee. A cafeteria plan will not fail to satisfy 
section 125 if it--
    (i) Changes the employee's election to provide coverage for the 
child if the order requires coverage for the child under the employee's 
plan; or
    (ii) Permits the employee to make an election change to cancel 
coverage for the child if the order requires the spouse, former spouse, 
or other individual to provide coverage for the child.
    (2) Example. The following example illustrates the application of 
this paragraph (d):

    Example. (i) Employer M maintains a calendar year cafeteria plan 
that allows employees to elect no health coverage, employee-only 
coverage, employee-plus-one-dependent coverage, or family coverage. 
M's employee, A, is married to B and they have one child, C. Before 
the beginning of the year, A elects employee-only health coverage. 
Employee A divorces B during the year and, pursuant to A's divorce 
agreement with B, M's health plan receives a qualified medical child 
support order (as defined in section 609 of the Employee Retirement 
Income Security Act of 1974) during the plan year. The order 
requires M's health plan to cover C.
    (ii) Under this paragraph (d), M's cafeteria plan may change A's 
election from employee-only health coverage to employee-plus-one-
dependent coverage in order to cover C.

    (e) Entitlement to Medicare or Medicaid. If an employee, spouse, or 
dependent who is enrolled in an accident or health plan of the employer 
becomes entitled to coverage (i.e., becomes enrolled) under Part A or 
Part B of Title XVIII of the Social Security Act (Medicare) (Public Law 
89-97 (79 Stat. 291)) or Title XIX of the Social Security Act 
(Medicaid) (Public Law 89-97 (79 Stat. 343)), other than coverage 
consisting solely of benefits under section 1928 of the Social Security 
Act (the program for distribution of pediatric vaccines), a cafeteria 
plan may permit the employee to make a prospective election change to

[[Page 15553]]

cancel or reduce coverage of that employee, spouse, or dependent under 
the accident or health plan. In addition, if an employee, spouse, or 
dependent who has been entitled to such coverage under Medicare or 
Medicaid loses eligibility for such coverage, the cafeteria plan may 
permit the employee to make a prospective election to commence or 
increase coverage of that employee, spouse, or dependent under the 
accident or health plan.
    (f) Significant cost or coverage changes. [Reserved]
    (g) Special requirements relating to the Family and Medical Leave 
Act. An employee taking leave under the Family and Medical Leave Act 
(FMLA) (Public Law 102-530 (88 Stat. 829)) may revoke an existing 
election of group health plan coverage and make such other election for 
the remaining portion of the period of coverage as may be provided for 
under the FMLA.
    (h) Elective contributions under a qualified cash or deferred 
arrangement. The provisions of this section do not apply with respect 
to elective contributions under a qualified cash or deferred 
arrangement (within the meaning of section 401(k)) or employee 
contributions subject to section 401(m). Thus, a cafeteria plan may 
permit an employee to modify or revoke elections in accordance with 
section 401(k) and (m) and the regulations thereunder.
    (i) Definitions. Unless otherwise provided, the definitions in 
paragraphs (i)(1) though (8) of this section apply for purposes of this 
section.
    (1) Accident or health coverage. Accident or health coverage means 
coverage under an accident or health plan as defined in regulations 
under section 105.
    (2) Benefit package option. A benefit package option means a 
qualified benefit under section 125(f) that is offered under a 
cafeteria plan, or an option for coverage under an underlying accident 
or health plan (such as an indemnity option, an HMO option, or a PPO 
option under an accident or health plan).
    (3) Dependent. A dependent means a dependent as defined in section 
152, except that, for purposes of accident or health coverage, any 
child to whom section 152(e) applies is treated as a dependent of both 
parents.
    (4) Disability income coverage. Disability income coverage means 
coverage under an accident or health plan that provides benefits due to 
personal injury or sickness, but does not reimburse expenses incurred 
for medical care (as defined in section 213(d)) of the employee or the 
employee's spouse and dependents, and does not provide for payments 
described in section 105(c).
    (5) Family member plan. A family member plan means a cafeteria plan 
or qualified benefit plan sponsored by the employer of the employee's 
spouse or the employee's dependent.
    (6) FSA, health FSA. An FSA means a qualified benefits plan that is 
a flexible spending arrangement as defined in section 106(c)(2) . A 
health FSA means a health or accident plan that is an FSA.
    (7) Placement for adoption. Placement for adoption means placement 
for adoption as defined in regulations under section 9801.
    (8) Qualified benefits plan. A qualified benefits plan means an 
employee benefit plan governing the provision of one or more benefits 
that are qualified benefits under section 125(f).
    (j) Effective date. This section is applicable for cafeteria plan 
years beginning on or after January 1, 2001.

    Par. 3. Sec. 1.125-4T is amended by revising paragraph (l) to read 
as follows:


Sec. 1.125-4T  Permitted election changes (temporary).

* * * * *
    (l) Effective date. This section is applicable for plan years 
beginning after December 31, 1998, and on or before November 6, 2000.

Robert E. Wenzel,
Deputy Commissioner of Internal Revenue.
    Approved: February 23, 2000.
Jonathan Talisman,
Acting Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 00-5817 Filed 3-22-00; 8:45 am]
BILLING CODE 4830-01-U