IRS flex benefit rules boost plans' appeal

WASHINGTON—Proposed Internal Revenue Service rules for flexible benefit plans give employees expecting big orthodontia expenses a new reason to smile.

The rules would allow employees to be reimbursed from their flexible spending accounts as soon as they pay an orthodontist's bill—a major exception to longstanding IRS policy that health care-related reimbursements from FSAs could not be made until after a service had been delivered.

That requirement posed cash-flow problems for employees with children needing orthodontia work. Because of the large expense for such services and dental insurance covering only part of the charges, orthodontists typically require that a significant portion of the bill be paid before performing the services. But employees couldn't immediately tap their FSAs to get reimbursed.

Now, under the IRS rules proposed earlier this month, "Once you receive the bill and write the check, you can get reimbursed," said J.D. Piro, an attorney with Hewitt Associates Inc. in Norwalk, Conn.

"It is a recognition of how things work in the real world," said Randy Abbott, a senior consultant with Watson Wyatt Worldwide in Wellesley Hills, Mass.

Making FSAs, which are funded with employees' pretax payroll contributions, more in tune to orthodontia billing practices is one example of how the IRS has shaped the flexible benefit rules to accommodate everyday situations, said Andy Anderson, of counsel with the law firm of Morgan, Lewis & Bockius L.L.P. in Chicago.

For example, the rules would allow employees to tap unused FSA balances to pay for dependent care expenses incurred after they terminate employment rather than forfeit the balances.

Additionally, the rules would allow newly hired employees to make flexible benefit plan selections that would apply from their date of hire—so long as they do so within 30 days of being hired.

For employees who lose group health care coverage, other provisions would allow them to pay premiums for COBRA health care continuation coverage with pretax contributions.

Tax advantages

Such a situation could occur when an employee goes from full-time to a part-time schedule, thus losing eligibility for group coverage and qualifying for COBRA. By enabling employees to pay COBRA premiums with pretax salary contributions, the true cost of coverage can be cut—depending on an employee's tax bracket—by more than one-third, thus making coverage more affordable.

The rules also would allow employees to use pretax dollars to pay for COBRA coverage in certain situations when they move from one employer to another.

For example, an employee may be eligible immediately to make contributions to a flexible spending account offered by his or her new employer but has to wait three months before enrolling in the new employer's health care plan. During that period, under the IRS rules, the employee could pay premium contributions for COBRA coverage offered by his or her former employer.

In such an arrangement, benefit consultants say, the employee would have his or her salary reduced and the pretax contributions would be used to pay the COBRA premium.

The new rules also would permit employees to make pretax contributions for privately purchased health care coverage—so long as their employer offers a flexible benefit program.

Mutually beneficial

That new flexibility would apply, for example, in situations where an employer offers part-time workers only a flexible benefit program but does not offer them a health plan. Those employees then could purchase coverage on their own, paying for the coverage with pretax dollars.

Mr. Anderson described this last feature of the IRS rules as a "win-win-win situation."

He noted that health insurance premiums will —because of the tax breaks—be more affordable for employees and possibly reduce the number of uninsured.

At the same time, Mr. Anderson said, employers benefit because the payment of health insurance premiums through salary reduction cuts the amount of payroll taxes paid by both employers and employees.

Experts not only praise the new rules for their added flexibility, but also for providing comprehensive guidance in one place.

"It is very welcome to have guidance pulled together in one comprehensive document," said Fran Bruno, an attorney with Mercer Human Resource Consulting in New York.

Still, some hope the IRS shows even more flexibility when it finalizes its rules.

For example, there are other health care-related expenses—such as infertility treatment—for which advance payment sometimes is required and should be eligible for the same favorable FSA reimbursement provided to orthodontia expenses, said Leslye Laderman, a director in Buck Consultants L.L.C.'s St. Louis office.

"Perhaps, there is an opportunity to get some things changed," she said.