Comments Concerning Cafeteria Plan Regulations
Under Internal Revenue Code Section 125

III.  Comments

A.  Significant Cost or Coverage Changes

6. Safe Harbor Approach
    
7. 1. Explanation of New Rule

   2. Prop. Treas. Reg. §1.125-4(f) sets forth rules for permitted election changes during a period of coverage as a result of significant cost or coverage changes. Unlike Q & A 6(c) in Prop. Treas. Regs. §§1.125-2 and 1.125-4 which contains examples and not a definitive list of circumstances of when an employee may change his or her election during a period of coverage, the Proposed 2000 Regulations do not appear to provide employers and plan administrators with discretion to permit a change in election as a result of a significant cost or coverage change unless it is one of the permitted election changes listed in the Proposed 2000 Regulations.

   3. Concerns

   4. An important issue to resolve in the Proposed 2000 Regulations is whether the events that permit election changes during a period of coverage are the only events for which employers may allow employees to change their elections, or whether they constitute a “safe harbor” thereby permitting election changes for other similar events. Although the approach taken in the Proposed 2000 Regulations may be helpful in providing definitive answers in certain circumstances, there are many transactions and events not enumerated in the Proposed 2000 Regulations, which may reasonably permit changes in elections without violating the constructive receipt rule.

   5. Recommendation

   6. We recommend that when the Proposed 2000 Regulations are finalized, they clarify that the permitted election change rules constitute a “safe harbor” that would permit employers to allow other events to qualify as permitted election changes. In order for employers to reasonably permit changes to occur in such instances while avoiding abusive situations, the Proposed 2000 Regulations may provide that changes will only be permitted to the extent that they are not intended to result in any “subterfuge” to the general constructive receipt rules.

      For example, a more appropriate approach would be one similar to that of the section 401(k) hardship distribution rules. Under the hardship distribution rules, events such as the purchase of a home, college education, medical expenses, etc. are enumerated events allowing hardship distributions. However, employers may also go beyond the safe harbor to grant hardship distributions in other circumstances. Although most employers do not take such action due to lack of guidance from the Service, employers nonetheless have the flexibility under the 401(k) hardship rules to take appropriate action to avoid unintended hardships to employees.

      Adopting such an approach with respect to permitted election changes would be a practical solution that would balance an employer’s human resources needs and the Service’s desire to prevent abusive situations. A nonexclusive safe harbor approach recognizes the reality of the workplace, where employers often must respond quickly to the many varied factual situations that occur in the lives of their employees. For example, many employers are instituting (and employees are electing) flexible and telecommuting work arrangements that could change the nature of dependent care arrangements. Such workplace changes may not coincide with the beginning of a new tax year and may not result in a reduction in the hours of employment. A safe harbor approach would permit employers the flexibility to make reasonable decisions based on the facts at hand and thereby avoid employee hardship.