CAFETERIA PLAN REGULATIONS

Although Section 125 of the Internal Revenue Code governing cafeteria plans has been with us for over two decades, the Internal Revenue Service has only issued proposed regulations to implement it. Until last year, that is.

All of the proposed and temporary regulations that have been issued since at least 1984 have not carried with them the effect of law, although the IRS has said that employers may rely on them when setting up a cafeteria plan. Final regulations governing one aspect of flexible benefit plan administration, however, were issued last March, applicable to plan years beginning on or after January 1, 2001. (Some more proposed regulations were also issued at the same time.)

As you know, flexible benefit programs require plan participants to make certain elections at the beginning of the plan year. These final regulations cover what status changes permit participants to make mid-year election changes in accident and health, and group term life plans. (The new proposed regulations deal with other benefits, such as dependent care and adoption assistance.) The regulations specify five status change events that will allow such election changes. They are:

1. Legal marital status (marriage, death of spouse, divorce, annulment, legal separation).
2. Number of dependents (birth, death, adoption, placing for adoption).
3. Employment status (of the employee, the employee's spouse or the employee's dependent).
4. Dependent satisfying or ceasing to satisfy eligibility requirements (such as student status or attainment of a certain age).
5. Residence (change in residence of employee, spouse or dependents). In addition, these regulations require any such election change to satisfy a "consistency rule." That is, the election change must be consistent with the status change that allows it. If there is a change in marital status or a dependent ceases to satisfy eligibility requirements, then an election to cancel accident and health coverage can only be for the individual involved. For example, if an employee's dependent child graduates from college and no longer qualifies for coverage under the health care plan, the employee cannot cancel coverage for his or her spouse because this would not correspond to the change in status that occurred.

An election to increase or decrease group term life insurance, however, will be deemed to correspond to a change in the employee's marital status or in the employment status of a spouse or dependent.

There is also an exception to the consistency rule for COBRA situations. A loss of coverage would, under the rule, usually require a decrease in the amount of an election, but an election can be made to increase payments under a cafeteria plan to pay for COBRA continuation coverage.

Similarly, if a judicial decree from a divorce, separation, change in legal custody, etc., including a qualified medical child support order, requires a result that would violate the consistency rule, the judicial order takes precedence and the inconsistent change can be allowed.

Keep in mind that the conditions under which changes in elections will be permitted must be specified in writing by the plan document. Furthermore, just because the regulations allow certain mid-year changes, the plan itself does not have to do so.

-- Christopher B. Ashton, CEBS

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