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Proposed Cafeteria Plan Regs Issued

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The Internal Revenue Service and the U.S. Treasury Department have released a 124-page draft of cafeteria plan regulations that could replace the tall pile of regulations, interim regulations, revenue rulings and notices that have been used to run the plans.

The proposed regulations deal with topics such as the fate of unused funds in cafeteria plan flexible spending arrangements, methods for calculating the amount of group life premiums that can be excluded from an employee’s taxable income, procedures for keeping a cafeteria plan from discriminating against ordinary employees, and interactions between cafeteria plans and other types of benefit plans.

The IRS hopes to hold a hearing on the proposed rule Nov. 15 and put most sections of the proposed rule into effect Jan. 1. 2009.

Benefits experts agreed that, in most cases, the proposed regulations appear to restate the rules that cafeteria plans have already been following.

“Nothing in the proposed regulations looks startling,” said Kevin O’Hara, a vice president at Corporate Synergies Group Inc., Mount Laurel, N.J., a benefits brokerage firm. “There’s nothing horrific.”

But “I think 124 pages is significant,” said Susan Relland, a benefits lawyer at Miller & Chevalier Chartered, Washington.

The proposed regulations make enough changes that most cafeteria sponsors will have to change plan documents, Relland predicts.

William Sweetnam Jr., a lawyer at Groom Law Group Chartered, Washington, who has been the benefits tax counsel at the U.S. Treasury Department, said the benefits community should expect to see the IRS draft many more comprehensive regulations in the next few years.

One reason is to simplify compliance for everyone, but another is many regulators are now in their 50s or 60s, Sweetnam said.

Before the veteran regulators retire, the IRS and the Treasury Department “want to make sure they have all that institutional knowledge written down,” Sweetnam said.

For insurance agents, brokers and consultants who work in the executive benefits market, the provisions in the proposed regulations of most interest may be sections that define terms such as officer, 5% shareholder, key employee, compensation and “highly compensated individual.”

Under a new test to determine when the election of benefits is discriminatory, the proposed regulations “provide that a cafeteria plan must give each similarly situated participant a uniform opportunity to elect qualified benefits and that highly compensated participants must not actually disproportionately elect qualified benefits,” officials wrote.

“A lot of companies haven’t really thought about nondiscrimination” in cafeteria plans, Sweetnam said. “They’ll have to do that now.”

Relland said she likes the idea that the IRS included the new discrimination test but would like to see the IRS clarify how it reached the conclusions in some of the discrimination test examples it provides.

Relland also would like to see the IRS add procedures for correcting minor errors in substantiation of cafeteria plan expenses, to keep accidental use of plan funds to buy a $3 hairbrush from invalidating an entire plan.

Today, “there are no correction procedures anywhere in these rules,” Relland said.

O’Hara would have liked to see the IRS and Treasury eliminate the FSA “use it or lose it” rule, which now requires FSA plan sponsors to take back unused FSA funds at the end of the plan year, but Sweetnam says Treasury officials sincerely believe they lack the authority to do so.

The proposed regulations do describe FSA grace period rules.

The section that describes calculations of the amount of employer group life contributions that must be included in an employee’s income does seem to provide a clearer procedure than the IRS has used in the past, Relland said.

At the end of the preamble to the proposed regulations, officials asked for comments on topics such as whether multiple employers may sponsor a single cafeteria plan and how salary reduction contributions could be based on employees’ tips.

Relland said she likes the question about treatment of tip income.

At Miller & Chevalier, some clients in the restaurant industry already have been asking questions about whether and how they can include tip income in FSA programs, Relland said.