NU Online News Service, Oct. 8, 7:15 p.m. – The Internal Revenue Service has issued a revenue ruling that could cause tax headaches for employees of companies that set up medical expense reimbursement plans in the middle of the year.

The ruling affects plans established under Section 105(b) of the Internal Revenue Code.

Once an employer establishes a Section 105 plan, employees can exclude any eligible reimbursements made through the plan from their taxable income.

But the new IRS revenue ruling, Revenue Ruling 2002-58, warns that employees can exclude reimbursements from taxable income only if the reimbursements are paid after an employer has officially started the plan.

“Reimbursements of medical expenses incurred prior to the establishment of a plan are not paid or received under an accident or health plan,” Shoshanna Chaiton, a regulator in the IRS division counsel’s office, writes in her explanation of the ruling. “Therefore, those amounts are not excludable from an employee’s gross income.”

The employer described in the ruling started a Section 105 plan Dec. 1, but it designed the plan so that the plan would reimburse employees for expenses incurred since the beginning of the year.

An employee who received reimbursement for medical expenses incurred before Dec. 1 and reimbursed before Dec. 1 wanted to exclude the reimbursement payments from taxable income.

But earlier revenue rulings and federal court decisions issued in 1971, 1992 and 1999 show that employees cannot use the Section 105 tax break retroactively, Chaiton writes.

The full text of the IRS ruling is available in the Sept. 23 issue of the Internal Revenue Bulletin, at http://www.irs.gov/pub/irs-irbs/irb02-38.pdf