Year-End Reminders and Health Care Reform Developments

Benefits Brief
November 7, 2013

The IRS has recently announced the various qualified plan related limits for 2014. The following table includes the most widely used limits relating to qualified plans and includes both the 2013 and 2014 amounts.

IRS Announces Key 2014 Indexed Limits



Compensation limit



Section 415(b) limit



Section 415(c) limit



Section 402(g)/401(k) limit



Catch-up contributions



HCE threshold



Officer (top heavy) threshold



Taxable wage base



Use of Tax-Favored Arrangements To Purchase Individual Health Insurance Prohibited Beginning in 2014

In a reversal of long-standing guidance, the IRS recently announced that effective for plan years beginning on or after January 1, 2014, employer subsidies for individual health insurance policies will be taxable, and employees may no longer use pre-tax dollars to pay for any of their share of the cost of these policies through a Section 125 ("cafeteria") plan.

Since the early 1960s, employers generally have been able to pay premiums directly or reimburse employees and former employees for the cost of individual health insurance policies without those payments or reimbursements being taxable to the individual. Similarly, subject to applicable nondiscrimination testing requirements, an employee could use pre-tax dollars under a Section 125 plan to pay for his or her own share of the cost of an individual health insurance policy.

The IRS has now determined that these arrangements, as well as certain health reimbursement arrangements ("HRAs"), violate the "market reform" provisions of the Affordable Care Act ("ACA"). While employers can continue to subsidize the cost of an individual health insurance policy, once the new rule becomes effective, employers may no longer do so on a tax-free basis, and employees will not be able to use pre-tax dollars to pay for such coverage. (It is possible, however, for an arrangement maintained solely for retirees to meet the ACA requirements, and HRAs coupled with employer-sponsored group health plans are still permitted.)

The IRS position results in a direct clash with a key requirement of the health care reform law adopted in Massachusetts in 2006. Under that law, Massachusetts employers with at least 11 employees are required to offer a Section 125 plan that permits certain employees to use pre-tax dollars to pay for individual health insurance policies available from the Massachusetts Health Connector. Although certain changes were made to the Massachusetts law this summer, the Section 125 plan requirement remained in place. In light of the new IRS position, the Connector has just announced that, pending action by the Massachusetts legislature to repeal the requirement, it will not be enforcing the Section 125 plan requirement, or enforcing the so-called "free rider" penalties against employers who do not maintain a Section 125 plan meeting Massachusetts health care reform requirements. Although Massachusetts employers may continue to permit employees to use a Section 125 plan to purchase individual health insurance policies from the Connector through the end of the plan year, if employees choose to do so they will be ineligible for federal premium tax credits, which may be more valuable than the tax benefits provided by a Section 125 plan. For employees who prefer to make a change, the IRS has provided relief from the irrevocable election requirement under Section 125. Under a special transition rule available for plan years beginning in 2013, employers may amend their Section 125 plan to permit employees to revoke or change their Section 125 plan elections mid-year as part of a change in their health coverage.

Employers who reimburse employees for individual health insurance policies or permit employees to purchase individual health insurance policies, including Connector policies, on a pre-tax basis should advise employees of these coming changes. If an employer wishes to permit employees to change or drop Section 125 plan elections mid-year, it will need to adopt an appropriate plan amendment (generally by December 31, 2014) to permit the change. 

Change to "Use-It or Lose-It" Rule for Health FSAs

In another reversal of long-standing guidance, the IRS recently relaxed the so-called "use-it or lose-it" feature of health care flexible spending accounts ("FSAs"), which generally prohibited unused health FSA contributions from being carried over into a new plan year. Under the new guidance, employers are permitted (but not required) to amend their health FSAs to permit participants to carry over up to $500 of unused amounts to the next plan year; any amount in excess of $500 (or a lower limit) must still be forfeited.

A health FSA may not offer both the new $500 carryover provision and the grace period option, whereby a participant may be reimbursed for expenses incurred during the first 2½ months of a plan year from prior year health FSA contributions. But an employer is, with a timely amendment, able to add either of these alternatives (or eliminate the grace period and add the carryover provision) as early as the current plan year. Employers with high deductible health plans and health savings account ("HSA") arrangements will also need to carefully consider how the carryover provision may effect HSA eligibility before amending the health FSA.

Finally, the IRS guidance provides detailed examples concerning how the carryover rules will work under various scenarios. If you are interested in further exploring this option, please contact a member of the Employment and Benefits Practice Group.

Qualified Plan Year-End Reminders

There is an ever growing list of annual notices that must be distributed in connection with the routine operation of qualified plans. That list includes the following:

If you have questions about these or other periodic reporting requirements, please feel free to contact a member of the Employment and Benefits Practice Group.