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STATUS CHANGES ADDRESSED IN IRS RULES ON FLEX PLANS

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WASHINGTON-New Internal Revenue Service rules provide employers who sponsor flexible benefit plans guidance on when employees can revoke or amend benefit elections because of "changes in status."

The new rules, published Friday in the Federal Register, update 1984 and 1989 IRS rules. Those earlier rules detail the requirements flexible benefit plans must follow in order for the plans to enjoy their special tax-favored status.

Under the most common flexible benefit plan, known as a premium conversion plan, employees can pay for health care and life insurance premiums with pretax dollars. In other flexible plans, employees contribute pretax dollars to a special account-known as a flexible spending account-to pay for uncovered health care-related and other benefit expenses. In a full-fledged flex plan, employees receive credits to "pay" for various benefit options, which have different price tags. Unused credits can be taken as cash.

The key condition the IRS has attached to flex plans is that benefit elections-such as how much an employee will contribute to an FSA-must be made prior to the start of the plan year and that the decision is irrevocable for the rest of that year.

However, the IRS earlier said there were certain situations of changes in status in which employees could revoke benefit elections made prior to the start of the plan year.

For example, if a spouse died during the middle of a year, an employee could move to single coverage from family coverage and reduce his or her pretax contributions.

The new regulations, though, update the earlier rules and offer new guidance on situations or changes in status.

"These rules will provide some answers for questions that employers had been grappling with," said Henry Saveth, a principal with William M. Mercer Inc. in Washington.

"These rules settle some questions for employers as to which events constitute a status change," according to John Piro, a consultant with Hewitt Associates L.L.C. in Rowayton, Conn.

The rules provide numerous examples in which previous benefit elections could be altered during the plan year. Those examples include:

An employee has a 21-year-old son who graduates from college and loses coverage under his parent's health care plan because the plan only allows dependent children over the age of 18 to receive coverage if they are full-time students.

In that situation, the employer could allow the employee to make pretax contributions in order to pay for the graduate's COBRA premiums.

An employee lives in an area where he or she can choose coverage from a traditional indemnity plan or from one of two health maintenance organizations. The employee selects one of the managed care plans.

During the year, the employee moves to a new area in which the employee's HMO does not operate, though the other HMO does.

In that situation, the employee can move to the indemnity plan or the second HMO or terminate coverage.

An employee opts for single coverage in an indemnity plan and agrees to contribute $600 to an FSA. The employee's spouse works for a different employer and has single coverage from her employer.

During the year, the spouse terminates employment and loses coverage.

Because the spouse has lost coverage, the employee wants to elect family coverage and to increase the amount contributed to the FSA. The IRS says a change would be permissible.

Other situations in which employees could change elections during the plan year would involve annulment of a marriage and a lockout or strike.

The IRS, though, did not address whether certain other situations, such as an increase in health care costs, would comprise a change in status and allow employees to revoke or amend earlier benefit elections.