While many school district employers sponsor an Internal Revenue Code Section 125 Cafeteria Plan, these arrangements and their component benefits can vary widely amongst each employer. Some districts have expanded features offered through their cafeteria plans in conjunction with cost-sharing strategies, including the addition of health and/or dependent care flexible spending accounts and health savings accounts, in an effort to provide more favorable tax treatment of the dollars employees must allocate toward health care. Further, as healthcare costs continue to rise, many districts have changed the design of their medical, dental, and other welfare and fringe benefit plans. Each of these changes can impact cafeteria plan provisions and administrative procedures. Finally, layered onto these types of voluntary changes, recent developments have led to required changes to cafeteria plans being needed.

As the sole vehicle available for affording employees the ability to pay for certain healthcare costs on a pre-tax basis, cafeteria plan sponsors will have to implement plan document changes to ensure their plans remain in compliance and continue to offer the intended favorable
tax treatment. 

So, what has changed?

Several administrative and legislative changes over the past few years have affected employer-sponsored cafeteria plans. Many of the changes impacting cafeteria plans have been in the form of discretionary or permissive features that may make a cafeteria plan more flexible or more attractive to employees. Most recently, however, legislative developments have had an even greater impact, as they have implemented required changes to cafeteria plans. Because of the variety of changes that have occurred, cafeteria plan documents will need to be updated. This process will help to ensure that a sponsor’s cafeteria plan is in compliance with statutory developments, as well as consistent with current plan operation and administrative practices.

Among the items that provided discretionary changes impacting cafeteria plans are the following:

• Over-the-counter drugs — Reimbursements of medical expenses through health flexible spending accounts for nonprescription (over-the-counter) drugs are permitted and excluded from income like other employer reimbursements of employee health expenses.
• More favorable definition of dependent — The definition of dependent under Internal Revenue Code Section 152 allows certain dependents such as full-time students to be eligible to participate in parents’ cafeteria plans with Medical and/or Dependent Care Flexible Spending Accounts (FSAs).
• Extended reimbursement period — Allows cafeteria plans to be modified to extend the deadline for incurring medical and/or dependent care expenses for reimbursement from flexible spending accounts (FSAs) up to two and a half months after the end of the plan year (grace period). An employee may apply any unused FSA funds from the plan year toward qualified expenses incurred during the grace period.
• Heroes Assistance and Relief Tax Act of 2008 (“HEART Act”) — Provided tax benefits and incentives to military personnel. The HEART Act permits plan sponsors to amend their cafeteria plans to allow employees called to active duty for at least 180 days to receive a distribution of their unused health flexible spending arrangement benefits.

 
Among the items that provided mandatory changes to cafeteria plans are the following:

• State Children’s Health Insurance Program (SCHIP) — Extended participants’ special enrollment rights as well as provided new special enrollment qualifying events, chiefly when certain other coverage is lost, or when subsidized coverage may be available. Changes are effective April 1, 2009; although plan documents were not required to be amended by this date.
• American Recovery and Reinvestment Act of 2009 (ARRA) — Amended COBRA to provide a premium subsidy to certain former employees.
• Proposed Treasury Regulations – This comprehensive guidance adds various clarifications to the cafeteria plan rules and provides new regulations governing cafeteria plan rule applicability to employees covered under FMLA. Further, the rules have been modified to specify that certain events qualify as a “change in family status” and, therefore, may provide more opportunities for mid-year election changes. Although the rules are “proposed,” they can be relied on and many plans have incorporated these rules.

 

What should sponsors do now?

Districts sponsoring a cafeteria plan should take the following steps:

• Amend the cafeteria plan to extend participants’ special enrollment rights and new special enrollment qualifying events as required by the SCHIP.
• Review the cafeteria plan’s COBRA language and amend the plan to provide more specific provisions relating to the new COBRA subsidy to avoid confusion and inconsistency with current plan provisions.
• Review your current medical plan and cafeteria plan design and administrative practices and, in particular, focus on identifying changes to practices which have been implemented over recent years. Update/amend the cafeteria plan to ensure that plan documentation appropriately allows for any such changes in your administrative practices.
• Consider the discretionary options discussed above and ensure the cafeteria plan is amended to reflect the district’s policies.
• Determine whether the voluntary changes permissible under the HEART Act are appropriate and, if so, amend the plan accordingly.

 
Finally, with the array of changes impacting cafeteria plans, including the pending issuance of final treasury regulations under Section 125 of the Internal Revenue Code in the near future, an increased likelihood of enhanced scrutiny of cafeteria plans is almost certain. Such scrutiny on the part of the IRS will likely exist with respect to both cafeteria plan documentation, and with respect to other compliance areas. Specifically, the proposed regulations have provided further guidance with respect to nondiscrimination testing requirements applicable to cafeteria plans. Once regulations are finalized, we expect that all plan sponsors of cafeteria plans will need to review their plan design and employee demographics to ensure that the more objective and defined tests are met.