[Federal Register Volume 65, Number 57 (Thursday, March 23, 2000)]
[Proposed Rules]
[Pages 15587-15592]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-5818]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-117162-99]
RIN 1545-AX59


Tax Treatment of Cafeteria Plans

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Partial withdrawal of notice of proposed rulemaking; amendment 
to notice of proposed rulemaking; and notice of proposed rulemaking.

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SUMMARY: This document withdraws portions of the notice of proposed 
rulemaking published in the Federal Register on March 7, 1989 and 
amends proposed regulations under section 125. These proposed 
regulations clarify the circumstances under which a section 125 
cafeteria plan election may be changed. The proposed 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, group-term life insurance 
coverage, dependent care assistance, and adoption assistance.

DATES: Written and electronic comments and requests for a public 
hearing must be received by June 21, 2000.

ADDRESSES: Send submissions to: CC:DOM:CORP:R (REG-117162-99), room 
5226, Internal Revenue Service, POB 7604, Ben Franklin Station, 
Washington, DC 20044. Submissions may be hand delivered between the 
hours of 8 am and 5 pm to: CC:DOM:CORP:R (REG-117162-99), Courier's 
Desk, Internal Revenue Service, 1111 Constitution Avenue NW., 
Washington, DC. Alternatively, taxpayers may submit comments 
electronically via the internet by selecting the ``Tax Regs'' option on 
the IRS Home Page, or by submitting comments directly to the IRS 
internet site at http://www.irs.gov/tax__regs/regslist.html.

FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Janet A. 
Laufer or Christine L. Keller at (202) 622-6080; concerning submissions 
or to request a public hearing, LaNita Van Dyke at (202) 622-7180. 
These are not toll-free numbers.

SUPPLEMENTARY INFORMATION:

Background

    Section 125 \1\ permits an employer to offer employees the choice 
between taxable income and certain nontaxable or ``qualified benefits'' 
\2\ through a cafeteria plan, without the employees having to recognize 
the taxable income. In 1984 and 1989, proposed regulations were 
published relating to the administration of cafeteria plans.\3\ 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.\4\ Specifically, Secs. 1.125-1, Q&A-8 and 1.125-2, Q&A-

[[Page 15588]]

6(b), (c) and (d) 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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    \1\ Revenue Act of 1978, Public Law 95-600 (November 6, 1978): 
Sen. Rep. 95-1263, 95th Cong., 2d Sess., 74-78, 186-187 (October 1, 
1978); H.R. Rep. No. 95-1445, 95th Cong. 2d Sess., 63-66 (August 4, 
1978); H.R. Rep. No. 95-250, 96th Cong., 2d Sess., 206-207, 253-254 
(October 15, 1978).
    \2\ ``Qualified benefits'' are generally any benefits excluded 
from income, 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. 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 section 127; and fringe benefits under section 132. Qualified 
benefits can be provided under a cafeteria plan either through 
insured arrangements or arrangements that are not insured.
    \3\ 49 FR 19321 (May 7, 1984) and 54 FR 9460 (March 7, 1989), 
respectively.
    \4\ 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), and 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. \5\ The 1997 regulations are being 
published as final regulations elsewhere in this issue of the Federal 
Register.
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    \5\ 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 these temporary regulations (Sec. 1.125-4T) and 
proposed regulations (Sec. 1.125-4) so that they will not be 
effective before plan years beginning at least 120 days after 
further guidance is issued.
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Explanation of Provisions

A. Summary

    The proposed regulations being published in this notice of proposed 
rulemaking were developed as part of an integrated package with the 
final regulations that are being published at the same time. These 
proposed regulations supplement the final regulations by permitting a 
mid-year cafeteria plan election change in connection with dependent 
care assistance and adoption assistance under change in status 
standards that are the same as the standards in the final regulations 
for accident or health plans and for group-term life insurance, and by 
adding change in status standards that are specific to dependent care 
and adoption assistance. These proposed regulations also refine and 
expand upon the approach adopted in the 1989 proposed regulations (at 
Sec. 1.125-2, Q&A-6(b)) by providing that a cafeteria plan may permit 
employees to make mid-year election changes with respect to group-term 
life insurance, dependent care assistance, and adoption assistance as 
well as accident or health coverage, on account of changes in cost or 
coverage. This expansion of the cost or coverage rules would also allow 
employees to make election changes if, during a period of coverage, (1) 
a new benefit package option is offered, or a benefit package option is 
eliminated, under the plan or (2) a coverage change is made under a 
plan of the employer of an employee's spouse or dependent. These 
proposed regulations include a variety of examples illustrating how the 
rules apply in specific situations.

B. Change in Status

    The proposed regulations published in this notice of proposed 
rulemaking complement the final regulations being published elsewhere 
in this issue of the Federal Register with respect to special 
enrollment rights and changes in status for accident or health coverage 
and group-term life insurance coverage. These proposed regulations take 
into account comments received on the 1997 temporary and proposed 
regulations, including comments suggesting the desirability of 
uniformity in the rules for different types of qualified benefits to 
the extent appropriate given the nature of the benefits.
    In response to comments, the new proposed regulations address 
circumstances under which a cafeteria plan may permit an employee to 
change an election for dependent care assistance under section 129 and 
adoption assistance under section 137 during a plan year. The proposed 
change in status rules for dependent care assistance and adoption 
assistance parallel the change in status rules for accident or health 
coverage and group-term life insurance coverage contained in the final 
regulations, with some additional rules specific to dependent care and 
adoption assistance. For example, while a change in the number of 
dependents is a status change for other types of qualified benefits, a 
change in the number of qualifying individuals, as defined in section 
21(b)(1), is a change in status for purposes of dependent care 
assistance. Likewise, these proposed regulations allow an additional 
change in status event for adoption assistance (the commencement or 
termination of an adoption proceeding). The consistency rule in the 
proposed regulations is the same as the consistency rule in the final 
regulations, with certain provisions that are specific to dependent 
care and adoption assistance changes.\6\
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    \6\ Conforming changes have also been made to Q&A-8 of the 1984 
proposed regulations under Sec. 1.125-1.
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C. Change in Cost or Coverage

    The new proposed regulations also address election changes to 
reflect significant cost and coverage changes for all types of 
qualified benefits provided under a cafeteria plan. The new proposed 
regulations refine and expand upon the approach taken in the 1989 
proposed regulations at Sec. 1.125-2, Q&A-6 with respect to changes in 
cost or coverage under the plan. For example, in response to comments, 
the new proposed regulations provide that if a plan adds a new benefit 
package option (such as a new HMO option), the cafeteria plan may 
permit affected participants to elect that option and make a 
corresponding election change with respect to other benefit package 
options during a period of coverage.
    The new proposed regulations also generally extend the cost or 
coverage rules under Sec. 1.125-2, Q&A-6(b) to permit election changes 
for self-insured accident or health plans, group-term life insurance, 
dependent care assistance and adoption assistance coverage under a 
cafeteria plan. Thus, for example, if the cost of a self-insured 
accident or health plan increases, a plan may automatically make a 
corresponding change in the salary reduction charge. In addition, the 
new proposed regulations treat a change of dependent care provider as 
similar to the addition of a new HMO option under an accident or health 
plan, with the result that a corresponding election change can be made 
when one dependent care provider is replaced by another. While the 
coverage change rules apply to dependent care regardless of whether the 
dependent care provider is related to the employee, the cost change 
rules do not apply to dependent care if the dependent care provider is 
a relative of the employee making the election.
    Commentators on the 1997 temporary and proposed regulations also 
raised a concern that when the plan of the employer of a spouse 
conducts annual open enrollment for group health benefits beginning at 
a different time of the year than the annual open enrollment for group 
health benefits offered by the employee's employer, the employee is 
unnecessarily restricted from making election changes that correspond 
with elections made by the employee's spouse. These commentators 
suggested that if one spouse makes an election change during an open 
enrollment period, a corresponding change should be permitted for the 
other spouse. In response to these comments, the new proposed 
regulations provide that a cafeteria plan may permit an employee to 
make an election change, during a period of coverage, corresponding 
with an open enrollment period change made by a spouse or dependent 
when the plan of that individual's employer has a different period of 
coverage.
    In addition, the new proposed regulations provide that a cafeteria 
plan may permit an employee to make an

[[Page 15589]]

election change in the event that a spouse or dependent makes an 
election change under a cafeteria plan (or qualified benefits plan) 
maintained by that individual's employer, provided that the spouse or 
dependent's election change satisfies the election change rules under 
the proposed regulation. For example, under this provision, if the plan 
of a spouse's employer adds a new HMO option to its group health plan, 
and the spouse elects to enroll the family in that new option, a 
cafeteria plan may permit the employee to drop family coverage. These 
new rules apply only if the change made by the employee is on account 
of and corresponds with the change made under the other employer's 
plan. This expansion of the existing cost or coverage change rules 
permits employees to make election changes to ensure consistent 
coverage of family members and eliminate duplicate coverage.
    The cost or coverage rules in the new proposed regulations have not 
been extended to health flexible spending arrangements. This ensures 
that those arrangements will not permit election changes in a manner 
that is inconsistent with the requirement, under Secs. 1.125-1, Q&A-17 
and 1.125-2, Q&A-7 of the existing proposed regulations, that such 
arrangements exhibit the risk-shifting and risk-distribution 
characteristics of insurance.
    Although the final regulations being published elsewhere in this 
issue of the Federal Register permit election changes in the event an 
individual becomes eligible (or loses eligibility) for Medicare or 
Medicaid, these proposed regulations do not address election changes to 
reflect an individual's eligibility for other government programs that 
pay for or subsidize health coverage.\7\ For example, the new rules do 
not address the possibility that an employee's child may cease to be 
eligible for coverage under a state's children's health insurance 
program (CHIP) designed in accordance with Title XXI of the Social 
Security Act.\8\ Comments are requested on whether eligibility or 
ineligibility for such a government program should be added to the 
types of events that allow a cafeteria plan election change (including 
any special administrative difficulties that employers might have in 
identifying this type of event) and, if so, the types of government 
programs that should be permitted to be taken into account.
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    \7\ The loss of coverage under a government program may give 
rise to a special enrollment right under section 9801(f) and, thus, 
the issue addressed here is relevant only in cases in which the 
special enrollment rules do not apply.
    \8\ Added to the Social Security Act by section 4901 of the 
Balanced Budget Act of 1997, Public Law 105-33 (August 5, 1997).
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D. Effective Date and Reliance

    The new proposed regulations do not specify a proposed effective 
date. Any effective date will be prospective, and comments are 
requested on the extent of lead time necessary for employers to be able 
to implement the new proposed regulations after they are adopted as 
final regulations.
    Until the effective date of further guidance, taxpayers may rely on 
the new proposed regulations. In addition, until the effective date of 
further guidance, taxpayers may continue to rely on the change in 
family status rules in the existing proposed regulations (at 
Sec. 1.125-2, Q&A-6(c)) with respect to benefits other than accident 
and health coverage and group-term life insurance coverage, and on the 
cost or coverage change rules in the existing proposed regulations (at 
Sec. 1.125-2, Q&A-6(b)) with respect to all types of qualified 
benefits.

Special Analyses

    It has been determined that this notice of proposed rulemaking 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) do not apply to these regulations, and because the 
regulations do 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 
proposed regulations will be submitted to the Chief Counsel for 
Advocacy of the Small Business Administration for comment on their 
impact on small business.

Comments and Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any written and electronic comments (a 
signed original and eight (8) copies) that are submitted timely to the 
IRS. The IRS and Treasury specifically request comments on the clarity 
of the proposed regulations and how they may be made easier to 
understand. All comments will be available for public inspection and 
copying. A public hearing will be scheduled if requested in writing by 
any 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 authors of these proposed 
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.

Partial Withdrawal of Notice of Proposed Rulemaking

    Under the authority of 26 U.S.C. 7805, Sec. 1.125 Q&A-6(c) and (d) 
in the notice of proposed rulemaking that was published on March 7, 
1989 (54 FR 9460) is withdrawn.

Amendments to Previously Proposed Rules

    The proposed rules published on May 7, 1984 (49 FR 19321) and March 
7, 1989 (54 FR 9460), and amended on November 7, 1997 (62 FR 60196), 
are amended as set forth below.

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 citation for part 1 continues to read in 
part as follows:


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

    Par. 2. In Sec. 1.125-1, as proposed to be added on May 7, 1984 (49 
FR 19322), in Q&A-8, Q-8 is republished and A-8 is amended by adding 
two sentences at the end of the answer to read as follows:


Sec. 1.125-1  Questions and answers relating to cafeteria plans.

* * * * *
    Q-8: What requirements apply to participants' elections under a 
cafeteria plan?
    A-8: * * * For benefit elections relating to accident or health 
plans and group-term life insurance coverage, a cafeteria plan may 
permit a participant to revoke a benefit election after the period of 
coverage has commenced and to make a new election with respect to the 
remainder of the period of coverage under the rules set forth in 
Sec. 1.125-4 pertaining to permitted election changes. For additional 
rules governing benefit elections, see Sec. 1.125-4.
* * * * *
    Par. 3. In Sec. 1.125-2, as proposed to be added on March 7, 1989 
(54 FR 9500) and amended November 7, 1997 (62 FR

[[Page 15590]]

60197), in Q&A-6, Q-6 is republished and A-6 is amended by:
    1. Adding a sentence at the end of paragraph (b)(2).
    2. Revising the last sentence of paragraph (c).
    3. Revising the last sentence of paragraph (d).
    The additions and revisions read as follows:


Sec. 1.125-2  Miscellaneous cafeteria plan questions and answers.

* * * * *
    Q-6: In what circumstance may participants revoke existing 
elections and make new elections under a cafeteria plan?
    A-6: * * *
    (b) * * *
    (2) * * * For additional rules governing cafeteria plan election 
changes in connection with a significant cost or coverage change, see 
Sec. 1.125-4.
    (c) Certain changes in family status. * * * For additional rules 
governing cafeteria plan election changes in connection with certain 
changes in status, see Sec. 1.125-4.
    (d) Separation from service. * * * For additional rules governing 
cafeteria plan election changes in connection with an employee's 
separation from service, see Sec. 1.125-4.
* * * * *
    Par. 4. Sec. 1.125-4 is amended as follows:
    1. Paragraph (c) is amended as follows:
    a. Revising paragraph (c)(1)(iii).
    b. Adding paragraph (c)(2)(vi).
    c. Revising paragraph (c)(3)(ii).
    d. Adding paragraphs (c)(4)Example 3(iii) and (c)(4)Example 9.
    2. Revising paragraph (f).
    3. Revising paragraph (g).
    4. Revising paragraph (i)(3).
    The additions and revisions read as follows:


Sec. 1.125-4  Permitted election changes.

* * * * *
    (c) * * * (1) * * *
    (iii) Application to other qualified benefits. This paragraph (c) 
applies to plans providing qualified benefits other than those listed 
in paragraph (c)(1)(ii) of this section.
    (2) * * *
    (vi) Adoption assistance. For purposes of adoption assistance 
provided through a cafeteria plan, the commencement or termination of 
an adoption proceeding.
    (3) * * *
    (ii) Application to other qualified benefits. An election change 
satisfies the requirements of this paragraph (c)(3) with respect to 
other qualified benefits 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. An election change also satisfies 
the requirements of this paragraph (c)(3) if the election change is on 
account of and corresponds with a change in status that affects 
expenses described in section 129 (including employment-related 
expenses as defined in section 21(b)(2)) with respect to dependent care 
assistance, or expenses described in section 137 (including qualified 
adoption expenses as defined in section 137(d)) with respect to 
adoption assistance.
* * * * *
    (4) * * *

    Example 3. * * *
    (iii) In addition, under paragraph (f)(4) of this section, if F 
makes an election change to cover G under F's employer's plan, then 
E may make a corresponding change to elect employee-only coverage 
under P's cafeteria plan.
* * * * *
    Example 9. (i) Employee A has one child, B. Employee A's 
employer, X, maintains a calendar year cafeteria plan that allows 
employees to elect coverage under a dependent care FSA. Prior to the 
beginning of the calendar year, A elects salary reduction 
contributions of $4,000 during the year to fund coverage under the 
dependent care FSA for up to $4,000 of reimbursements for the year. 
During the year, B reaches the age of 13, and A wants to cancel 
coverage under the dependent care FSA.
    (ii) When B turns 13, B ceases to satisfy the definition of 
``qualifying individual'' under section 21(b)(1) of the Internal 
Revenue Code. Accordingly, B's attainment of age 13 is a change in 
status under paragraph (c)(2)(iv) of this section that affects A's 
employment-related expenses as defined in section 21(b)(2). 
Therefore, A may make a corresponding change under X's cafeteria 
plan to cancel coverage under the dependent care FSA.
* * * * *
    (f) Significant cost or coverage changes--(1) In general. 
Paragraphs (f)(2) through (5) of this section set forth rules for 
election changes as a result of changes in cost or coverage. This 
paragraph (f) does not apply to an election change with respect to a 
health FSA (or on account of a change in cost or coverage under a 
health FSA).
    (2) Cost changes--(i) Automatic changes. If the cost of a qualified 
benefits plan increases (or decreases) during a period of coverage and, 
under the terms of the plan, employees are required to make a 
corresponding change in their payments, the cafeteria plan may, on a 
reasonable and consistent basis, automatically make a prospective 
increase (or decrease) in affected employees' elective contributions 
for the plan.
    (ii) Significant cost increases. If the cost of a benefit package 
option (as defined in paragraph (i)(2) of this section) significantly 
increases during a period of coverage, the cafeteria plan may permit 
employees either to make a corresponding prospective increase in their 
payments, or to revoke their elections and, in lieu thereof, to receive 
on a prospective basis coverage under another benefit package option 
providing similar coverage. For example, if the cost of an indemnity 
option under an accident or health plan significantly increases during 
a period of coverage, employees who are covered by the indemnity option 
may make a corresponding prospective increase in their payments or may 
instead elect to revoke their election for the indemnity option and, in 
lieu thereof, elect coverage under an HMO option.
    (iii) Application to dependent care. This paragraph (f)(2) applies 
in the case of a dependent care assistance plan only if the cost change 
is imposed by a dependent care provider who is not a relative of the 
employee. For this purpose, a relative is an individual who is related 
as described in section 152(a)(1) through (8), incorporating the rules 
of section 152(b)(1) and (2).
    (3) Coverage changes--(i) Significant curtailment. If the coverage 
under a plan is significantly curtailed or ceases during a period of 
coverage, the cafeteria plan may permit affected employees to revoke 
their elections under the plan. In that case, each affected employee 
may make a new election on a prospective basis for coverage under 
another benefit package option providing similar coverage. Coverage 
under an accident or health plan is significantly curtailed only if 
there is an overall reduction in coverage provided to participants 
under the plan so as to constitute reduced coverage to participants 
generally.
    (ii) Addition (or elimination) of benefit package option providing 
similar coverage. If during a period of coverage a plan adds a new 
benefit package option or other coverage option (or eliminates an 
existing benefit package option or other coverage option) the cafeteria 
plan may permit affected employees to elect the newly-added option (or 
elect another option if an option has been eliminated) prospectively on 
a pre-tax basis and make corresponding election changes with respect to 
other benefit package options providing similar coverage.
    (4) Change in coverage of spouse or dependent under other 
employer's plan. A cafeteria plan may permit an employee to make a 
prospective election change that is on account of and

[[Page 15591]]

corresponds with a change made under the plan of the spouse's, former 
spouse's or dependent's employer if--
    (i) A cafeteria plan or qualified benefits plan of the spouse's, 
former spouse's, or dependent's employer permits participants to make 
an election change that would be permitted under paragraphs (b) through 
(g) of this section (disregarding this paragraph (f)(4)); or
    (ii) The cafeteria plan permits participants to make an election 
for a period of coverage that is different from the period of coverage 
under the cafeteria plan or qualified benefits plan of the spouse's, 
former spouse's, or dependent's employer.
    (5) Examples. The following examples illustrate the application of 
this paragraph (f):

    Example 1. (i) A calendar year cafeteria plan is maintained 
pursuant to a collective bargaining agreement for the benefit of 
Employer M's employees. The cafeteria plan offers various benefits, 
including indemnity health insurance and a health FSA. As a result 
of mid-year negotiations, premiums for the indemnity health 
insurance are reduced in the middle of the year, insurance co-
payments for office visits are reduced under the indemnity plan, and 
an HMO option is added.
    (ii) Under these facts, the reduction in health insurance 
premiums is a reduction in cost. Accordingly, under paragraph 
(f)(2)(i) of this section, the cafeteria plan may automatically 
decrease the amount of salary reduction contributions of affected 
participants by an amount that corresponds to the premium change. 
However, the plan may not permit employees to change their health 
FSA elections to reflect the mid-year change in copayments under the 
indemnity plan.
    (iii) Also, the addition of the HMO option is an addition of a 
benefit package option. Accordingly, under paragraph (f)(3)(ii) of 
this section, the cafeteria plan may permit affected participants to 
make an election change to elect the new HMO option. However, the 
plan may not permit employees to change their health FSA elections 
to reflect differences in copayments under the HMO option.
    Example 2. (i) Employer N sponsors a group health plan under 
which employees may elect either employee-only coverage or family 
health coverage. The 12-month period of coverage under N's cafeteria 
plan begins January 1, 2001. N's employee, A, is married to B. 
Employee A elects employee-only coverage under N's plan. B's 
employer, O, offers health coverage to O's employees under its group 
health plan under which employees may elect either employee-only 
coverage or family coverage. O's plan has a 12-month period of 
coverage beginning September 1, 2001. B maintains individual 
coverage under O's plan at the time A elects coverage under N's 
plan, and wants to elect no coverage for the plan year beginning on 
September 1, 2001, which is the next period of coverage under O's 
group health plan.
    (ii) Under paragraph (f)(4)(ii) of this section, N's cafeteria 
plan may permit A to change A's election prospectively to family 
coverage under that plan effective September 1, 2001 if B actually 
elects no coverage under O's group health plan for the plan year 
beginning on September 1, 2001.
    Example 3. (i) Employer P sponsors a calendar year cafeteria 
plan under which employees may elect either employee-only or family 
health coverage. Before the beginning of the year, P's employee, C, 
elects family coverage under P's cafeteria plan. C also elects 
coverage under the health FSA for up to $200 of reimbursements for 
the year to be funded by salary reduction contributions of $200 
during the year. C is married to D, who is employed by Employer Q. Q 
does not maintain a cafeteria plan, but does maintain a group health 
plan providing its employees with employee-only coverage. During the 
calendar year, Q adds family coverage as an option under its health 
plan. D elects family coverage under Q's plan, and C wants to revoke 
C's election for health coverage and elect no health coverage under 
P's cafeteria plan for the remainder of the year.
    (ii) Q's addition of family coverage as an option under its 
health plan constitutes a new coverage option described in paragraph 
(f)(3)(ii) of this section. Accordingly, pursuant to paragraph 
(f)(4)(i) of this section, P's cafeteria plan may permit C to revoke 
C's health coverage election if D actually elects family health 
coverage under Q's group health plan. Employer P's plan may not 
permit C to change C's health FSA election.
    Example 4. (i) Employer R maintains a cafeteria plan under which 
employees may elect accident or health coverage under either an 
indemnity plan or an HMO. Before the beginning of the year, R's 
employee, E elects coverage under the HMO at a premium cost of $100 
per month. During the year, E decides to switch to the indemnity 
plan, which charges a premium of $140 per month.
    (ii) E's change from the HMO to indemnity plan is not a change 
in cost or coverage under this paragraph (f), and none of the other 
election change rules under paragraphs (b) through (e) of this 
section apply. While R's health plan may permit E to make the change 
from the HMO to the indemnity plan, R's cafeteria plan may not 
permit E to make an election change to reflect the increased 
premium. Accordingly, if E switches from the HMO to the indemnity 
plan, E may pay the $40 per month additional cost on an after-tax 
basis.
    Example 5. (i) Employee A is married to Employee B and they have 
one child, C. Employee A's employer, M, maintains a calendar year 
cafeteria plan that allows employees to elect coverage under a 
dependent care FSA. Child C attends X's on site child care center at 
an annual cost of $3,000. Prior to the beginning of the year, A 
elects salary reduction contributions of $3,000 during the year to 
fund coverage under the dependent care FSA for up to $3,000 of 
reimbursements for the year. Employee A now wants to revoke A's 
election of coverage under the dependent care FSA, because A has 
found a new child care provider.
    (ii) The availability of dependent care services from the new 
child care provider (whether the new provider is a household 
employee or family member of A or B or a person who is independent 
of A and B) is a significant change in coverage similar to a benefit 
package option becoming available. Thus, M's cafeteria plan may 
permit A to elect to revoke A's previous election of coverage under 
the dependent care FSA, and make a corresponding new election to 
reflect the cost of the new child care provider.
    Example 6. (i) Employee D is married to Employee E and they have 
one child, F. Employee D's employer, N, maintains a calendar year 
cafeteria plan that allows employees to elect coverage under a 
dependent care FSA. Child F is cared for by Y, D's household 
employee, who provides child care services five days a week from 9 
a.m. to 6 p.m. at an annual cost in excess of $5,000. Prior to the 
beginning of the year, D elects salary reduction contributions of 
$5,000 during the year to fund coverage under the dependent care FSA 
for up to $5,000 of reimbursements for the year. During the year, F 
begins school and, as a result, Y's regular hours of work are 
changed to five days a week from 3 p.m. to 6 p.m. Employee D now 
wants to revoke D's election under the dependent care FSA, and make 
a new election under the dependent care FSA to an annual cost of 
$4,000 to reflect a reduced cost of child care due to Y's reduced 
hours.
    (ii) The change in the number of hours of work performed by Y is 
a change in coverage. Thus, N's cafeteria plan may permit D to 
reduce D's previous election under the dependent care FSA to $4,000.
    Example 7. (i) Employee G is married to Employee H and they have 
one child, J. Employee G's employer, O, maintains a calendar year 
cafeteria plan that allows employees to elect coverage under a 
dependent care FSA. Child J is cared for by Z, G's household 
employee, who is not a relative of G and who provides child care 
services at an annual cost of $4,000. Prior to the beginning of the 
year, G elects salary reduction contributions of $4,000 during the 
year to fund coverage under the dependent care FSA for up to $4,000 
of reimbursements for the year. During the year, G raises Z's 
salary. Employee G now wants to revoke G's election under the 
dependent care FSA, and make a new election under the dependent care 
FSA to an annual amount of $4,500 to reflect the raise.
    (ii) The raise in Z's salary is a significant increase in cost 
under paragraph (f)(2)(ii) of this section, and an increase in 
election to reflect the raise corresponds with that change in 
status. Thus, O's cafeteria plan may permit G to elect to increase 
G's election under the dependent care FSA.

    (g) Special requirements relating to the Family and Medical Leave 
Act. [Reserved]
* * * * *
    (i) * * *
    (3) Dependent. A dependent means a dependent as defined in section 
152, except that, for purposes of accident or health coverage, any 
child to whom section 152(e) applies is treated as a

[[Page 15592]]

dependent of both parents, and, for purposes of dependent care 
assistance provided through a cafeteria plan, a dependent means a 
qualifying individual (as defined in section 21(b)(1)) with respect to 
the employee.
* * * * *

Robert E. Wenzel,
Deputy Commissioner of Internal Revenue.
[FR Doc. 00-5818 Filed 3-22-00; 8:45 am]
BILLING CODE 4830-01-U