Comments Concerning Cafeteria Plan Regulations
Under Internal Revenue Code Section 125

III.  Comments

A.  Significant Cost or Coverage Changes

2. Significant Cost Decrease
    
3. 1. Explanation of New Rule

   2. If the cost of a benefits package option significantly increases during a period of coverage, a cafeteria plan may permit employees to either make a corresponding prospective increase in their payments, or to revoke their elections and, in lieu thereof, to receive on a prospective basis coverage under another benefits package option providing similar coverage. Prop. Treas. Reg. §1.125-4(f)(2)(ii).

   3. Concerns

   4. In contrast to automatic changes in an employee’s elective contributions under a cafeteria plan if the cost of a benefits option increases or decreases during a period of coverage, the Proposed 2000 Regulations do not allow employees to make an election change (or a new election for an option) upon a significant decrease in the cost of a benefits package option. Because of the lack of flexibility in this new rule, many employees may hesitate to participate in cafeteria plans since their wages may be reduced by more than the actual cost of the coverage. Expanding the scope of the significant cost changes to include a significant decrease in the cost of coverage would be helpful in two areas.

      First, in some cases coverage may first become affordable upon a significant decrease in cost. Many employers contribute towards health insurance (as well as other benefits) at a higher rate for full-time employees as compared to part-time employees, thereby making the net cost of the coverage lower for full-time employees. If a part-time employee who is already eligible for benefits switches to full-time status mid-year, his or her net cost of the coverage may now be decreased. Such a change is not currently covered by Treas. Reg. 1.125-4(c)(2)(iii) because that provision would only cover the situation of an ineligible part-time employee first becoming eligible under the plan mid-year.

      Second, in the case of a Dependent Care FSA, the fees of most dependent care providers are based on the level of care rendered to the child, which in most cases are based upon the developmental abilities of the child. For example, dependent care fees could be reduced mid-year because a child moved from the infant room to the toddler room. Since levels of care are mostly based upon the developmental progression of the child, most employees participating in the Dependent Care FSA will not be able to anticipate any change in their dependent care provider fees at the beginning of the year with any level of certainty. Based on Examples 5 and 6 in the Proposed 2000 Regulations it is unclear whether the above reasons for such a cost decrease would be a change in a benefit package option allowing for an election change under Prop. Treas. Reg. 1.125-4(f)(3)(ii).

   5. Recommendation

   6. We recommend that the rules regarding significant cost or coverage changes be expanded in the final regulations to permit an employee to change his or her election if there is a significant decrease in the cost of coverage. Since employees who change their elections based upon a cost decrease will, in most instances, be turning prior nontaxable income into taxable wages, allowing such a change should satisfy the reasons for the constructive receipt rule and should not be a "subterfuge" to circumvent the permitted election change rules.