Health care reform has come to us in bits and pieces. The Senate passed their version on December 28, 2009. The House was working on their version at the same time. However, because of a shift in the Senate majority, the consensus from the House was to create a “reconciliation” bill in order to make changes to the bill approved by the Senate. They would, in turn, pass the Senate bill and the reconciliation bill to make it a complete package.
President Barack Obama signed into law the “Patient Protection and Affordable Care Act” (Health Care Act) on March 23, 2010, followed by the signing of the “Health Care and Education Reconciliation Act of 2010” on March 30.
These massive health care acts will certainly change the health care industry as we know it, with transformations phased in over several years. But, instead of detailing every change, for the purpose of this article, I’ll focus on flexible spending account (FSA) changes that will impact employers and their employees in the near future.
The Good
Definition of a Qualified Child. The Health Care Act changed the definition of a qualifying child to include any child of the taxpayer who has not reached the age of 27 as of the end of the tax year. However, keep in mind that the child will have to meet the other requirements as outlined under IRC Section 152(f)(1). The effective date of this change was March 20, 2010, with an exception for some grandfathered plans.
Simple Cafeteria Plans. The basics are simple, hence the name. Employers may skip all the applicable non-discrimination requirements for cafeteria plans under IRC Section 125 during the plan year if they adhere to three simple rules:
1. The employer is an “eligible” employer.
2. An eligible employer provides a required contribution.
3. The plan passes the eligibility and participation requirements.
In fact, an eligible employer who follows all the rules can skip the non-discrimination requirements under IRC Section 79(d) for group term life insurance, Section 105(h) pertaining to health FSAs, plus Section 129 for dependent care plans.
An eligible employer is one who employed 100 or fewer employees on business days during either of the two preceding years. If the employer has not been in existence for two years, their figures can be based on the average number of employees reasonably expected to be employed on business days in the current year.
Even if employers grow and have more than 100 employees, they can retain their eligibility to maintain a simple cafeteria plan. Employers will lose eligibility to offer the simple plan for a subsequent year if an average of 200 or more individuals are employed on business days during any preceding year.
Of course, if the employer outgrows a simple cafeteria plan, a traditional plan can be started, subject to the non-discrimination requirements.
The contribution rule states that eligible employers are required to make contributions for qualified benefits on behalf of each qualified employee, without regard to whether a qualified employee makes any salary reduction.
The contributions to each qualified employee must be:
• An amount equal to a uniform percentage (not less than 2 percent) of compensation for the plan year or
• An amount which is not less than 6 percent of the employee’s compensation for the plan year or twice the amount of the salary reduction contributions of each qualified employee.
For example, if an employee redirects $1,200 for the plan year and makes $50,000 in compensation that year, the contribution would need to be at least $1,000 (2 percent of compensation) or the lesser of $3,000 (6 percent of compensation) or $2,400 (twice the amount of salary reduction).
Matching contributions on behalf of highly compensated or key employees cannot be at a greater rate than for those who are not highly compensated or a key employee. However, an eligible employer may make additional contributions above the minimum requirements as long as they are not provided at a greater rate to highly compensated or key employees.
Minimum eligibility and participation requirements are:
• All employees who had at least 1,000 hours of service for the preceding plan year are eligible.
• Each employee eligible to participate in the plan may, subject to the terms and conditions applicable to all participants, elect any benefit available under the plan.
A qualified employee is anyone who is eligible to participate in the plan. However, certain employees may be excluded from participating in the plan if they:
• Have not attained age 21 before the close of a plan year.
• Have less than one year of service with the employer as of any day during the plan year.
• Are covered under a collective bargaining agreement.
• Are non-resident aliens working outside the United States.
A plan may provide for a shorter period of service or younger age for these exclusions, as determined by the employer.
Eligible employers may begin setting up simple cafeteria plans starting January 1, 2011.
Adoption Assistance Plans. For tax years beginning after December 31, 2009, the adoption tax credit is increased by $1,000 and is refundable on the employee’s tax return. The increased amount is available through 2011.
The Bad
Health Savings Account (HSA) and Archer Medical Savings Account (Archer MSA). For account holders of an HSA or Archer MSA, non-qualified distributions before the account holder reaches age 65 or is disabled will see an increase in the additional tax due. Starting in 2011, the additional tax will be 20 percent of the non-qualified distribution.
W-2. Beginning with the 2011 tax year, employers will be required to report the value of any employer-sponsored health care coverage on an employee’s W-2.
The Ugly
Over-The-Counter (OTC) Medications. Starting on January 1, 2011, OTC medications cannot be reimbursed from an FSA, HSA or a health reimbursement arrangement (HRA) unless they are accompanied by a doctor’s prescription.
However, all is not lost. This new ruling does not exclude all OTC expenses. Items like aspirin and cough syrup would be out, unless a doctor’s prescription is obtained for their use. Items like adult diapers, blood glucose monitors and diabetic test strips can still be purchased on a pre-tax basis without a doctor’s prescription.
Participants that utilize a health care debit card will no longer be able to use their card at the drug store or pharmacy for OTC drugs and medications. They may obtain a prescription for these items from their doctor and turn in a paper claim to their administrator along with the doctor’s prescription.
Enrollments are taking place now. Employers and their employees must be made aware of the OTC changes in order for participants to accurately determine their annual election to the FSA. For HRAs, the employer sets the limit, and HRAs roll from one year to another. Although neither the HRA nor the HSA may reimburse OTC drugs and medications once 2011 begins, there is no risk of loss to participant salary redirections from these types of plans.
Health FSA Contribution Limit. A contribution limit will apply to health FSAs starting January 1, 2013. Previously, there were no Internal Revenue Service limits placed on individuals or cafeteria plans and the employer set the limit for their cafeteria plan.
Under the health care reform act, health FSAs are limited to $2,500 per year. This dollar amount will be indexed for inflation starting after 2013.
The information contained in this article is not intended to be legal, accounting, or other professional advice. We assume no liability whatsoever in connection with its use, nor are these comments directed to specific situations.
