Health and Welfare: Modification of "Use-or-Lose" Rule for Health FSAs

Fred Oliphant and Allison Rogers

On October 31, 2013, Treasury published Notice 2013-71 ("Notice") which liberalizes the FSA "Use-or-Lose" rule ("Use-or-Lose" or the "Rule"). Use-or-Lose requires that unused amounts remaining at the end of a plan year in a health FSA be forfeited to the employer. The Rule derives from the Internal Revenue Code ("Code") Section 125's prohibition on arrangements that have the effect of deferring compensation under a cafeteria plan. In 2005, Treasury and the IRS acted to mitigate the effect of Use-or-Lose by permitting unused amounts to be used to cover expenses incurred for certain qualified benefits arising in the 2-1/2 month period following the end of the plan year ("Grace Period Rule").

The new Notice will now permit employers to amend their cafeteria plan documents to provide for the carryover of up to $500 of remaining amounts in a health FSA to the immediately following plan year to pay for or reimburse plan participants for qualified medical expenses during the entire plan year to which it is carried over. The carryover amount does not count against or otherwise affect the indexed $2,500 salary reduction limit for each plan year and it still must be used only to pay for or reimburse qualified medical expenses (i.e., no cash-out or conversion to other benefits is permitted). Under the Notice, an employer may choose to adopt the new carryover rule or the old Grace Period Rule, but not both.

To take advantage of the new carryover provision, the Notice specifies that the employer must amend its cafeteria plan document on or before the last day of the plan year from which amounts may be carried over and that such amendment may be effective retroactively to the first day of the plan year, provided the cafeteria plan operates in conformity with the Notice and notifies participants of the carryover provision. Special transition relief is afforded with respect to this amendment requirement -- an employer may adopt the amendment giving effect to the carryover provision for a plan year that began in 2013 as late as the end of the plan year that begins in 2014. Note that if the cafeteria plan currently provides for the Grace Period Rule, and the employer wishes to adopt the new carryover provision, the Grace Period Rule must be removed by no later than the end of the plan year from which the amounts may be carried, and there does not appear to be any transition relief granted with respect to this requirement, so that for cafeteria plans with a plan year beginning in 2013, it appears that the Grace Period Rule must be eliminated by the end of that plan year if the employer wishes to adopt the new carryover provision. The Notice further cautions that the employer's ability to eliminate the Grace Period Rule for a plan year after the plan year has already started may be subject to other (i.e., non-tax) legal constraints.

The Notice also clarifies certain prior cafeteria plan transition relief for mid-year elections issued in connection with the proposed regulations under Code Section 4980H. This relief permits employers that offer non-calendar year cafeteria plans that begin in 2013 to amend their plan documents for the plan year beginning in 2013 to allow one or both of the following election changes: (1) Permit their employees who have elected a salary reduction to prospectively revoke or change their election with respect to the accident and health plan once during that plan year; or (2) Permit their employees who have failed to make a salary reduction election prior to the amendment, to make a prospective salary reduction election on or after the first day of the 2013 plan year of the cafeteria plan. The Notice clarifies that this relief is available whether or not the employer is an applicable large employer subject to the "pay or play" penalties under Code Section 4980H, and that employers may choose to apply this relief in a more restrictive manner.

Employment Taxes: IRS Releases Streamlined Employment Tax Correction Procedures Following Windsor

Marianna Dyson and Michael Chittenden

As promised in the FAQs issued in conjunction with Rev. Rul. 2013-17, the IRS on September 23, 2013 released employment tax guidance in the form of Notice 2013-61. The Notice provides streamlined procedures for employers seeking to file corrected employment tax returns for earlier open periods in light of the Supreme Court's decision in United States v. Windsor, 570 U.S. ___(2013), 133 S.Ct. 2675. Employers seeking to take advantage of the streamlined procedures for 2013 will need to act quickly.

The Court's decision to strike down Section 3 of the Defense of Marriage Act ("DOMA") (which defined marriage, for purposes of federal law, as between one man and one woman) has tax implications for employers, including changes to whether certain fringe benefits are taxed. Before the decision, health benefits provided to same-sex spouses (and in some cases, their children) were subject to both federal income tax withholding and FICA taxation. Pursuant to Rev. Rul. 2013-17, issued on August 29, 2013, same-sex relationships denominated as "marriage" under state law will be eligible for federal tax benefits.

Notice 2013-61 provides simplified procedures for correcting the federal employment tax treatment for both 2013 and earlier open years (generally, 2010 through 2012). The most streamlined correction options are available for the current year. Employers who take steps to correct any federal income tax withholding and FICA taxation of same-sex spouse benefits during the third quarter of 2013 before the Form 941 for that quarter (due no later than October 31) is filed may make those corrections on the Form 941. Similarly, employers correcting the employment tax treatment of same-sex spouse benefits for all of 2013 may do so, in the aggregate, on the fourth quarter Form 941 (due no later than January 31, 2014), without having to file a Form 941-X for each earlier calendar quarter in 2013.

Employers should consider gathering information immediately on which employees have same-sex spouses, so that they can take advantage of the streamlined correction procedures for 2013. Notice 2013-61 also provides streamlined procedures for correcting the overpayment of FICA taxes in earlier open years by using a single Form 941-X for the fourth quarter of the year. Employers who are unable to complete the steps necessary to correct the application of FICA taxes in 2013 may also use the streamlined procedures applicable to earlier open years (i.e., a single Form 941-X for the fourth quarter of 2013 may be used to correct the FICA tax treatment of same-sex spouse benefits for the entire year).

Qualified Plans: Upcoming Amendment and Disclosure Deadlines

Elizabeth Drake**

It is time again for plan sponsors of tax-qualified retirement plans with calendar plan years to review their plans to determine whether any year-end amendments are required and to provide necessary participant disclosures. The following should be helpful in guiding that review:

Tax-Qualification Amendments

• Section 436 funding-based limits on accelerated payments and benefit accruals (applicable to all single-employer defined benefit pension plans). In 2009, the IRS issued final regulations under Section 436. In Notice 2011-96, the IRS provided additional guidance that included a sample amendment and a deadline for adopting Section 436 amendments. In Notice 2012-70, the IRS extended this deadline to, generally, the last day of the first plan year beginning in 2013 (i.e., December 31, 2013, for calendar plan years). Employers should review their defined benefit plans to ensure they have been properly amended to reflect the requirements of Section 436.
   
• Section 411(b)(5) interest crediting and market rate of return and Section 411(a)(13) three-year vesting rule (applicable to all cash balance and other hybrid defined benefit pension plans). In Notice 2011-85, the IRS set as a deadline for adopting Section 411(b)(5) and Section 411(a)(13) amendments the last day of the first plan year before the plan year for which the proposed market rate hybrid plan regulations, when finalized, take effect. The proposed regulations were released on October 19, 2010, and the IRS stated in Notice 2012-61 that final regulations will not become effective earlier than January 1, 2014. The IRS has not yet issued the final regulations, so it seems unlikely that any amendments will be required this year.

Discretionary Amendments 

• Changes in plan design and plan administration. Employers generally need to amend their plans to reflect changes in plan design and plan administration by the end of the first plan year in which they become effective. It is important to remember, however, that certain changes (e.g., the reduction of future benefit accruals, certain changes to 401(k) safe harbor plans) must be adopted in advance pursuant to specific statutory and regulatory requirements.

Amendments Arising from Windsor Decision

The Supreme Court in Windsor held Section 3 of DOMA, which limited marriage under federal law to those marriages between a man and a woman, unconstitutional. In response, the IRS issued Rev. Rul. 2013-17, which adopted the "state of celebration" approach, meaning that the IRS will recognize all same-sex marriages that were legally performed, regardless of the laws of the couple's current state of domicile. Rev. Rul. 2013-17 was effective as of September 16, 2013, and it does not currently apply retroactively to qualified retirement plans, according to Q&A-18 of a recent IRS FAQ. The IRS plans to issue further guidance on retroactive application of Windsor to employee benefit plans, including qualified plans, and specifically intends to address the substance and timing of plan amendments. The IRS has stated informally that it will not require plan amendments before the end of the year.

On September 18, 2013, the DOL issued Technical Release 2013-14, which adopted the "state of celebration" approach espoused by the IRS. No effective date or information on retroactive application was provided, but EBSA intends to issue future guidance addressing Windsor's application to specific ERISA provisions.

Extended Remedial Plan Amendment Period -- "Cycle C" Filers 

• Deadline for determination letter applications. An individually-designed plan must apply for a determination letter by the end of its five-year cycle in order to qualify for an extended remedial amendment period. During the extended remedial amendment period, the plan document can be amended retroactively to correct qualification errors in the plan's provisions. The current five-year cycle for Cycle C plans -- those plans sponsored by employers with tax identification numbers ending in 3 or 8 -- ends on January 31, 2014. Under Rev. Proc. 2012-50, governmental plans may elect Cycle C or Cycle E of the current remedial amendment cycle, regardless of which cycle the governmental plan elected as its previous remedial amendment cycle. The IRS issues an annual cumulative list of changes in plan qualification requirements, and the list that the IRS will review in connection with Cycle C submissions is set forth in IRS Notice 2012-76.
   
  Note: Before filing for a determination letter, employers should review their plans to ensure that all amendments since the last determination letter have been timely adopted. If any amendment was not timely adopted, or if there is a lack of clear documentation showing when an amendment was adopted, the employer should consider an IRS voluntary correction program (VCP) filing. IRS sanctions are significantly lower in VCP than when the IRS discovers the failure during the determination letter process.

Participant Notices

• Qualified Default Investment Alternative ("QDIA") Notice. Employers utilizing a QDIA for participants who do not make affirmative investment elections must provide an annual notice to participants with investments in the QDIA at least 30 days before the end of each plan year. The notice must include a description of the circumstances under which funds will be invested in the QDIA, a description of the QDIA, and an explanation of participants' right to direct their investments. 
   
• 401(k) Automatic Enrollment Notice. Employers with 401(k) plans that utilize automatic enrollment and automatic increase features must provide an annual notice to covered employees at least 30 days before the end of each plan year. The notice must inform participants how automatic deferrals will be invested in the absence of an affirmative investment direction, and how to opt out of or change the level of contributions.
   
• 401(k) Safe Harbor Notice. Employers with 401(k) plans that utilize a non-elective or matching contribution safe harbor alternative to ADP and ACP nondiscrimination testing must provide an annual notice to all eligible employees at least 30 days before the end of each plan year. Among other things, the notice must describe the safe harbor contribution, any other contributions, withdrawal and vesting provisions applicable to contributions, and how to make deferral elections. 
   
• Annual Fee Disclosures. Employers with participant-directed 401(k) or other defined contribution plans must provide an annual disclosure of certain investment and fee information. The disclosure must describe when participants may direct investments, identify any voting or other rights arising from investments, identify any investment manager, and include information on investment options, including any brokerage windows or similar arrangements. Additionally, the disclosure must communicate certain administrative fees for general plan services and how those fees are allocated, as well as individual expenses.
   
• Summary Annual Report. Employers with defined contribution plans are required to provide a summary annual report to all participants no later than two months after the Form 5500 due date (i.e., by December 15 for plans that filed their Form 5500 with an extension through October 15). Employers with defined benefit plans with more than 100 participants need not provide a summary annual report, instead they must provide an annual funding notice generally within 120 days after the close of each plan year (i.e., by April 30 for calendar year plans).

IRS Releases 2014 Cost of Living Adjustments

On October 31, 2013, the IRS released the cost of living adjustments applicable to retirement plans for the 2014 tax year (see IR-2013-86).

The following annual limits remain unchanged from 2013:

• Maximum elective deferral for § 401(k) and § 403(b) plans -- $17,500
• Maximum catch-up contribution under § 414(v) for employees age 50 and over -- $5,500 
• Highly compensated employee threshold in § 414(q) -- $115,000

The following annual limits will increased in 2014: 

• Defined benefit maximum annual benefit under § 415(b) -- $210,000 
• Defined contribution maximum annual addition under § 415(c) -- $52,000 
• Qualified plan compensation limit -- $260,000  
   

Health and Welfare: Upcoming Healthcare Reform Deadlines and Effective Dates

Fred Oliphant, Garrett Fenton, and Allison Rogers

Although there has been a steady roll-out of health care reform guidance since the Patient Protection and Affordable Care Act ("PPACA") was enacted on March 23, 2010, the statute is rapidly approaching its most transformative phase with a number of substantive provisions that begin to take effect January 1, 2014. While some of these provisions have been delayed or do not directly impact employers -- including the recently-announced delay of the individual mandate penalty, by up to two months, in connection with individual health insurance coverage purchased through an Exchange -- there are a number of provisions of interest to employers that will be applicable after the end of this year. Below we summarize some of these important upcoming requirements, focusing on those that are of importance to employers/group health plan sponsors.

• Employer Shared Responsibility (Pay or Play). Although originally scheduled to go into effect January 1, 2014, the IRS has delayed the employer mandate (and corresponding annual information reporting) provisions. The Pay or Play rules require "applicable large employers" to offer all full-time employees (and their children up to age 26) sufficiently "affordable" and "valuable" health coverage, or risk being assessed a penalty tax. The related IRS information reporting requirements imposed on employers are designed to assist the government in enforcing these rules. Pursuant to the IRS's announced delay, the Pay or Play and related IRS information reporting provisions are now scheduled to go into effect on January 1, 2015 (with the first information reports due in early 2016). Despite the delay, the implementation will be complicated and employers should not wait too long before making decisions regarding how best to prepare. An added complication is that future guidance on the Pay or Play rules and the information requirements could change the relevant landscape.
   
• Prohibition against Excessive Waiting Periods. Many employer-sponsored group health plans currently do not impose any waiting periods, or if they do, such waiting periods do not extend beyond 90 days. But this is not always the case, particularly in certain industries with higher employee turnover rates (e.g., retail stores, restaurant chains, etc.). For plan years beginning on or after January 1, 2014, PPACA prohibits group health plans from applying any waiting periods that exceed 90 days. All calendar days count towards this 90 day period. If the 91st day following an employee's eligibility for coverage falls on a weekend or holiday, the plan may need to make the waiting period shorter than 90 days, for administrative convenience; the effective date of coverage may not, in any event, occur after the 91st day. Employers should review their plan documents closely to make sure they comply with this rule. For example, based on the current, proposed regulations, employers who impose a waiting period of three months (or more), or provide for coverage to be effective as of the first day of the month immediately following the completion of a 90-day waiting period, may violate this rule.
   
• Wellness Programs. PPACA codified and amended the wellness program nondiscrimination regulations applicable under HIPAA, effective for plan years beginning on or after January 1, 2014. For example, the PPACA provisions increased the maximum incentive that an employer may offer under a "health contingent" wellness program from 20% to 30% of the total cost of coverage (with a permissible increase to 50% in connection with programs that aim to reduce tobacco use). Participation-only wellness programs continue to have no maximum incentive limit. The rules also clarified the distinctions between, and requirements for, participation-only and health-contingent wellness programs. Employers who offer (or would like to offer) wellness programs should consider whether to amend their programs to provide for an increased incentive, and whether they need to make any changes to comply with the updated rules.
   
• Preexisting Conditions. PPACA prohibits group health plans and health insurance issuers, for plan years beginning on or after January 1, 2014, from denying or limiting coverage to any individual based on a preexisting condition. This prohibition has applied with respect to children under age 19 since the first plan or policy year beginning on or after September 23, 2010, and is now being expanded to all participants and beneficiaries. Employers thus should confirm that their plans have eliminated any preexisting condition exclusions or limitations that previously may have applied to any enrollees, regardless of their age.
   
• Clinical Trial Coverage. Effective for plan years beginning on or after January 1, 2014, where an enrollee in a non-grandfathered group health plan is eligible to participate in an approved clinical trial for cancer or another life threatening disease or condition -- and either (1) the referring provider is a participating provider who has concluded that the enrollee's participation in the trial would be appropriate, or (2) the enrollee furnishes medical and scientific information establishing that participation in the trial would be appropriate -- the plan may not deny participation in the trial; deny, limit or impose additional conditions upon the coverage of routine patient costs for items and services furnished in connection with the trial; or discriminate against an enrollee based on his or her participation in the trial. The federal government has yet to issue any implementing regulations under these provisions and has indicated that such regulations may not be forthcoming in the immediate future. In the meantime, plans will be expected to adopt a "good faith, reasonable interpretation" of the statute.
   
• Prohibition Against Annual Limits. Effective for plan years beginning on or after January 1, 2014, group health plans may not establish any annual dollar limits on essential health benefits ("EHB"). This prohibition has actually applied since the first plan or policy year beginning on or after September 23, 2010, but certain "restricted" annual dollar limits have been permissible in the meantime. In classifying which benefits are EHB, and therefore subject to this prohibition, self-funded and large fully-insured group health plans may refer to any state's designated "benchmark" plan. (A separate PPACA provision, effective for plan or policy years beginning on or after January 1, 2014, requires individual and small group health insurance coverage to cover all EHB, which are defined for each state by reference to a specified benchmark plan.) Moreover, the IRS has clarified that because employer-provided health reimbursement arrangements ("HRAs") constitute group health plans, and necessarily include dollar limits on benefits, they will violate these rules if they are offered on a "stand-alone" basis -- i.e., if they are not "integrated" with another group health plan -- unless they are otherwise exempt from the rules (for example, as a retiree-only HRA).
   
  If they have not done so already, employers should review their plans' designs, select a benchmark plan to be used in defining EHB, and confirm that no annual dollar limits are imposed on such EHB. Employers also should confirm that they do not offer any non-retiree-only, stand-alone HRAs. For example, an HRA under which an employer makes a specified dollar amount available for active employees to pay individual health insurance premiums -- a so-called "defined contribution health plan" approach -- would likely violate these provisions.
   
• Reinsurance Fee. For calendar years 2014, 2015 and 2016, HHS will assess a transitional reinsurance program fee on employers that sponsor self-funded group health plans (and insurers of fully-insured group health plans and individual health insurance coverage). The amount of the fee is $63 per covered life in 2014, and is expected to decrease in 2015 and 2016. By no later than November 15 of each respective year, the self-funded plan (generally the employer, or a TPA on its behalf) must submit to HHS an annual enrollment count of the number of covered lives for the year, using one of several specified enrollee counting methodologies. Within 30 days of submission of the annual enrollment count, or by December 15, whichever is later, HHS will notify the employer of the total reinsurance contribution amount owed, based on that annual enrollment count. Within 30 days after the date of notification of contributions due for the applicable benefit year, the employer (or the TPA on its behalf) must remit the contributions to HHS.
   
  HHS will provide details on the process for submission of the reinsurance contributions in future guidance. Notably, HHS recently announced that it was intending to propose in future rulemaking to collect reinsurance contributions in two separate installments for each calendar year: one at the beginning of the following calendar year, and one at the end of the following calendar year. HHS also intends to propose to exempt from the fee entirely certain self-insured, self-administered plans -- which are not very common -- from the requirement to make reinsurance contributions for 2015 and 2016.
   
• Cost-Sharing / Out-of-Pocket Limitations. For plan years beginning in 2014, PPACA limits the total annual cost-sharing (or "out-of-pocket maximum") imposed by group health plans to the annual cost-sharing limit applicable to high deductible health plans that are compatible with health savings accounts (subject to increase in future years). For 2014, the applicable cost-sharing limits are $6,350 for self-only coverage, and $12,700 for any other coverage tier. Employers should review their plans to confirm that they meet these cost-sharing requirements.
   
• Annual Deductible Limits. For plan years beginning on or after January 1, 2014, a fully-insured, non-grandfathered small group health plan must not impose deductibles that exceed $2,000 for self-only coverage and $4,000 for any other tier of coverage (subject to specified increases after January 1, 2014). (A limited exception may apply if the health insurance issuer offering the small group coverage must impose a higher deductible in order for the coverage to provide an actuarial value that meets one of the specified "metal levels" of coverage, i.e., bronze (60% actuarial value), silver (70% actuarial value), gold (80% actuarial value) or platinum (90% actuarial value).)

Although many employers have already established their plan designs for 2014, it would be a good idea to review those plan designs now to ensure that they are compliant with the various provisions taking effect next year.

Employment Taxes: The U.S. Supreme Court Grants Cert in the Quality Stores Case

Marianna Dyson and Michael Lloyd

The Supreme Court, not surprisingly, granted cert on October 1, 2013 in the Quality Stores case. The Court is now poised to resolve a conflict between the Sixth Circuit and the Federal Circuit regarding whether severance payments paid to employees pursuant to an involuntary reduction in force are "wages" subject to FICA taxation. Notably, Justice Kagan did not participate in the order granting the petition, perhaps because she had some involvement in the case during her tenure as Solicitor General. Her recusal creates the theoretical possibility that the Court could ultimately divide 4-4 on the case and thus be unable to resolve the conflict. The government's opening brief is due November 15, 2013. Oral argument has been scheduled for January 14, 2014 and a decision will be issued in late Spring.

In the interim, what should an employer do?

(1) Regardless of the circuit in which the employer resides, we are advising our clients to continue withholding FICA taxes on severance payments otherwise satisfying the requirements of section 3402(o) until the Supreme Court rules.

(2) The employer may also want to consider filing refund claims with the IRS before the three-year period of limitations expires. For employment taxes withheld and paid in calendar year 2010, the three-year period will expire on April 15, 2014, for employers who timely filed their Forms 941. A decision to file a protective refund claim for later years may be deferred for the time being.

(3) If the IRS has denied an employer's refund claim for an earlier calendar year, the law provides that an employer has two years in which to file a refund action either in the U.S. District Court or the U.S. Court of Federal Claims. For those employers bumping up against this 2-year deadline, we are recommending that they consider filing a Form 907, "Agreement to Extend the Time to Bring Suit," with the IRS, following the very specific instructions for preparation, submission and execution. Of course, if the IRS has not yet denied the employer's refund claim, the two-year period has not begun to run and a Form 907 would not be necessary.

Attorneys in Miller & Chevalier's Employee Benefits group have filed hundreds of these claims over the years and, therefore, we have developed an efficient and cost-effective procedure to assist employers with this endeavor. Please let us know if we can be of assistance. 

For additional information, please contact any of the following attorneys in our ERISA/Employee Benefits practice:

Anthony Shelley, ashelley@milchev.com, 202-626-5924

Jeanette Dayan*

Elizabeth Drake*

Marianna Dyson*

Mike Chittenden*

Michael Lloyd*

Fred Oliphant*

Gary Quintiere*

Anthony Provenzano*

Allison Rogers*

Lee Spence*

*Former Miller & Chevalier attorney

**With special thanks to Nicholas Wamsley, Law Clerk at Miller & Chevalier and student at Georgetown University Law Center, for his contributions to this article.

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