The IRS has released an information letter addressing the treatment of cafeteria plan forfeitures. The letter responds to a question about whether unused funds in a cafeteria plan are paid to the U.S. Treasury when the employer ceases operations and the plan terminates, explaining that Code § 125 does not include such a requirement. Instead, the disposition of unused funds when a cafeteria plan terminates depends on the plan document’s provisions regarding plan termination and the facts and circumstances at the time. The letter also explains that proposed regulations under Code § 125 provide rules regarding the treatment of unused amounts forfeited by employees under an ongoing cafeteria plan. Under these rules, forfeitures may be used to defray plan expenses, allocated among participants on a reasonable and uniform basis (but not based on claims experience), or retained by the employer.
The letter also responds to a question on behalf of an employee whose unused health FSA funds had been forfeited at termination of employment. The plan provided that unused funds were forfeited upon termination unless the employee submitted a claim within 60 days for eligible medical expenses incurred on or before the termination date. Because the employee had no unreimbursed medical expenses to submit, the funds were forfeited. The letter explains that the plan’s action was consistent with IRS rules prohibiting the reimbursement of expenses incurred after an employee ceases to participate in the plan.
Comment: This IRS information letter does not break new ground or include any surprises. But like other recent IRS information letters, it may be helpful to those on the “front lines” of cafeteria plan administration, who are sometimes asked to explain the reasons for plan operating rules and decisions. Note that ERISA’s requirements must also be considered when determining what can be done with forfeitures under health FSAs that are subject to ERISA. Likewise, non-ERISA plans (e.g., health FSAs that fall within ERISA’s governmental or church plan exceptions, or DCAPS, which generally are not subject to ERISA) may have state-law requirements to consider. Employers can reduce the likelihood of forfeitures by offering a grace period or health FSA carryovers. Also remember that terminating employees (and their covered spouses and dependent children) must be given the opportunity to continue their health FSA coverage under COBRA unless an exception applies.