Effect of the Family and Medical Leave Act on the Operation of Cafeteria Plans

DEPARTMENT OF THE TREASURY

26 CFR Part 1

[EE-20-95]

RIN 1545-AT47

Effect of the Family and Medical Leave Act on the Operation of

Cafeteria Plans

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking.

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SUMMARY: This document contains proposed regulations relating to

cafeteria plans that reflect changes made by the Family and Medical

Leave Act of 1993. The proposed regulations provide the public with

guidance needed to comply with the Act and affect employees who

participate in cafeteria plans.

DATES: Written comments and requests for a public hearing must be

received by March 20, 1996.

ADDRESSES: Send submissions to: CC:DOM:CORP:R (EE-20-95), room 5228,

Internal Revenue Service, POB 7604, Ben Franklin Station, Washington,

DC 20044. In the alternative, submissions may be hand delivered between

the hours of 8 a.m. and 5 p.m. to: CC:DOM:CORP:R (EE-20-95), Courier's

Desk, Internal Revenue Service, 1111 Constitution Avenue NW.,

Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Catherine

Fuller, (202) 622-6080; concerning submissions and the hearing, Mike

Slaughter, (202) 622-8452 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

This document contains proposed additions to the Income Tax

Regulations (26 CFR Part 1) under section 125 of the Internal Revenue

Code of 1986 (Code). These additions are proposed to conform the

regulations to the Family and Medical Leave Act of 1993 (FMLA), Public

Law 103-3. FMLA imposes certain requirements on employers regarding

coverage, including family coverage, under group health plans for

employees taking FMLA leave, and regarding the restoration of benefits

to employees who return from FMLA leave. This notice of proposed

rulemaking addresses a number of the principle questions that have been

raised about how these FMLA requirements affect the operation of

cafeteria plans (including flexible spending arrangements) maintained

under section 125 of the Code. The rules in this notice of proposed

rulemaking supplement the proposed Income Tax Regulations under section

125 of the Code. Except as otherwise provided in this notice of

proposed rulemaking, all of the existing rules governing cafeteria

plans, including the nondiscrimination rules, continue to apply.

The requirements pertaining to FMLA leave, including the employer's

obligation to maintain coverage under a group health plan during FMLA

leave and to restore benefits upon return from FMLA leave, are

established by FMLA,

[[Page 66230]]

not the Code. The U.S. Department of Labor, in 29 CFR part 825, has

published rules interpreting the requirements of FMLA, and the

Department of Labor has jurisdiction relating to those rights or

obligations. This notice of proposed rulemaking does not interpret

FMLA; it provides guidance on the cafeteria plan rules that apply to an

employee in circumstances to which FMLA and the Labor Regulations

thereunder also apply. The Department of Labor has advised the

Department of the Treasury, including the Internal Revenue Service

(IRS), that the provisions of this notice of proposed rulemaking do not

conflict with, and are not inconsistent with, the provisions of FMLA or

the Labor Regulations thereunder.

Special Analyses

It has been determined that this notice of proposed rulemaking is

not a significant regulatory action as defined in EO 12866. Therefore,

a regulatory assessment is not required. It also has been determined

that section 553(b) of the Administrative Procedure Act (5 U.S.C.

chapter 5) and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do

not apply to these regulations, and, therefore, a Regulatory

Flexibility Analysis is not required. Pursuant to section 7805(f) of

the Code, this notice of proposed rulemaking will be submitted to the

Chief Counsel for Advocacy of the Small Business Administration for

comment on its impact on small business.

Comments and Requests for a Public Hearing

Before these proposed regulations are adopted as final regulations,

consideration will be given to any written comments (a signed original

and eight (8) copies) that are submitted timely to the IRS. All

comments will be available for public inspection and copying. A public

hearing may be scheduled if requested in writing by a person that

timely submits written comments. If a public hearing is scheduled,

notice of the date, time, and place for the hearing will be published

in the Federal Register.

Drafting Information

The principal author of these regulations is Catherine Fuller,

Office of Associate Chief Counsel (Employee Benefits and Exempt

Organizations). However, other personnel from the IRS and Department of

the Treasury participated in their development.

List of Subjects in 26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

Paragraph 1. The authority for part 1 continues to read in part as

follows:

Authority: 26 U.S.C. 7805 * * *

Par.Section 1.125-3 is added to read as follows:

Sec. 1.125-3 Effect of the Family and Medical Leave Act (FMLA) on the

operation of cafeteria plans.

Q-1: May an employee taking FMLA leave revoke an existing election

of group health plan coverage under a cafeteria plan?

A-1: Yes. An employee taking FMLA leave may revoke an existing

election of group health plan coverage (including a health flexible

spending arrangement (FSA)) under a cafeteria plan for the remaining

portion of the coverage period. See 29 CFR 825.209(e). FMLA also

requires that an employee be permitted to choose to be reinstated in

the group health plan coverage (including a health FSA) provided under

a cafeteria plan upon returning from FMLA leave if the employee's group

health plan coverage terminated while on FMLA leave (either by

revocation or nonpayment of premiums). Such an employee is entitled,

under FMLA, to be reinstated on the same terms as prior to taking FMLA

leave (including family or dependent coverage). See 29 CFR 825.209(e)

and 825.215(d). However, the employee has no greater right to benefits

for the remainder of the plan year than an employee who has been

continuously working during the plan year. In addition to the rights

granted under FMLA, such an employee has the right to revoke or change

elections (e.g., because of changes in family status or significant

cost or coverage changes imposed by a third-party provider) under the

same terms and conditions as are available to employees participating

in the cafeteria plan who are not on FMLA leave.

Q-2: Who is responsible for making premium payments under a

cafeteria plan when an employee on FMLA leave continues group health

plan coverage?

A-2: An employee is entitled to continue group health plan coverage

(including a health FSA) during FMLA leave whether or not provided

under a health FSA or other component of a cafeteria plan. See 29 CFR

825.209(b). An employee making premium payments under a cafeteria plan

who chooses to continue group health plan coverage (including a health

FSA) while on FMLA leave is responsible for the share of group health

premiums that the employee was paying while working, such as amounts

paid pursuant to a salary reduction agreement. The employer must

continue to contribute the share of the cost of the employee's coverage

that the employer was paying before the employee commenced FMLA leave.

See 29 CFR 825.100(b) and 825.210(a).

Q-3: What payment options are required or permitted to be offered

under a cafeteria plan to an employee who continues group health plan

coverage (including a health FSA) while on unpaid FMLA leave, and what

is the tax treatment of these payments?

A-3: (a) In general A cafeteria plan may, on a nondiscriminatory

basis, offer one or more of the following payment options (subject to

the limitations described in paragraph (b) of this Q&A-3) to an

employee who continues group health plan coverage (including a health

FSA) while on unpaid FMLA leave. These options are referred to in this

section as pre-pay, pay-as-you-go and catch-up.

(1) Pre-pay. (i) Under the pre-pay option, a cafeteria plan may

permit an employee to pay, prior to commencement of the FMLA leave

period, the amounts due for the FMLA leave period. However, the Labor

Regulations under FMLA provide that under no circumstances may the

employer mandate that an employee pre-pay the amounts due for the leave

period. See 29 CFR 825.210(c)(3) and (4).

(ii) Contributions under the pre-pay option may be made on a pre-

tax salary reduction basis from any taxable compensation (including the

cashing out of unused sick days or vacation days). These contributions

will not be included in the employee's gross income, provided that all

cafeteria plan requirements are satisfied. For example, see Q&A-5 of

this section regarding restrictions on pre-tax salary reduction

contributions when an employee's FMLA leave spans two cafeteria plan

years.

(iii) Contributions under the pre-pay option may also be made on an

after-tax basis. See Prop. Treas. Reg. Sec. 1.125-1, Q&A-5.\1\

\1\ Published as a proposed rule at 49 FR 19321 (May 7, 1984).

[[Page 66231]]

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(2) Pay-as-you-go. (i) Under the pay-as-you-go option, employees

may pay their share of the premium payments on the same schedule as

payments would be made if the employee were not on leave or under any

other payment schedule permitted by the Labor Regulations at 29 CFR

825.210(c) (i.e., on the same schedule as payments are made under the

Consolidated Omnibus Reconciliation Act of 1985, Public Law 99-272;

under the employer's existing rules for payment by employees on leave

without pay; or under any other system voluntarily agreed to between

the employer and the employee that is not inconsistent with this

section or with 29 CFR 825.210(c)).

(ii) Contributions under the pay-as-you-go option are generally

made by the employee on an after-tax basis. However, contributions may

be made on a pre-tax basis to the extent that the contributions are

made from taxable compensation (e.g., cashing out unused sick or

vacation days) that is due the employee during the leave period, and

provided that all cafeteria plan requirements are satisfied.

(iii) An employer is not required to continue the health coverage

of an employee who fails to make required premium payments while on

FMLA leave. See 29 CFR 825.212. However, if the employer chooses to

continue the health coverage of an employee who fails to make required

premium payments while on FMLA leave, the employer is entitled to

recoup those payments as set forth in paragraph (a)(3)(i) of this Q&A-

3. See also Q&A-6 of this section regarding coverage under a health FSA

when an employee fails to make the required premium payments while on

FMLA leave.

(3) Catch-up. (i) An employer that continues providing group health

coverage to an employee who does not pay premiums on FMLA leave is, to

the extent provided under the Labor Regulations, permitted to utilize

the catch-up option to recoup the employee's share of premium payments.

See, e.g., 29 CFR 825.212(b).

(ii) Where an employee is electing to use the catch-up option, the

employer and the employee must agree in advance of the coverage period

that: the employee elects to continue health coverage while on unpaid

FMLA leave; the employer will assume responsibility for advancing

payment of the premiums on the employee's behalf during the FMLA leave;

and these advance amounts must be paid by the employee when the

employee returns from FMLA leave.

(iii) Contributions under the catch-up option may be made on a pre-

tax salary reduction basis when the employee returns from FMLA leave

from any available taxable compensation (including the cashing out of

unused sick days and vacation days). These contributions will not be

included in the employee's gross income, provided that all cafeteria

plan requirements are satisfied.

(iv) Contributions under the catch-up option may also be made on an

after-tax basis. See Prop. Treas. Reg. Sec. 1.125-1, Q&A-5.\2\

\2\ Published as a proposed rule at 49 FR 19321 (May 7, 1984).

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(b) Exceptions. Cafeteria plans may offer (pursuant to 29 CFR

825.210(c)) one or more of the payment options described in paragraph

(a) of this Q&A-3, with the following exceptions:

(1) The pre-pay option cannot be the sole option offered to

employees on FMLA leave. However, the cafeteria plan may include pre-

payment as an option for employees on FMLA leave, even if such option

is not offered to employees on non-FMLA leave- without-pay.

(2) The catch-up option can be the sole option offered to employees

on FMLA leave if and only if the catch-up option is the sole option

offered to employees on non-FMLA leave-without-pay.

(3) A cafeteria plan cannot offer employees on FMLA leave a choice

of either the pre-pay option or the catch-up option without also

offering the pay-as-you-go option, if the pay-as-you- go option is

offered to employees on non-FMLA leave-without-pay.

(c) Voluntary waiver of employee payments. In addition to the

foregoing payment options, an employer may voluntarily waive, on a

nondiscriminatory basis, the requirement that employees who elect to

continue health coverage while on FMLA leave pay the amounts the

employees would otherwise be required to pay for the leave period.

Q-4: Do the special FMLA requirements concerning an employee who

continues group health plan coverage under a cafeteria plan apply if

the employee is on paid FMLA leave?

A-4: No. The Labor Regulations provide that, if an employee's FMLA

leave is substituted paid leave as described at 29 CFR 825.207 and the

employee continues group health plan coverage while on FMLA leave, the

employee's share of the premiums must be paid by the method normally

used during any paid leave (i.e., salary reduction). See 29 CFR

825.210(b).

Q-5: What restrictions apply to contributions when an employee's

FMLA leave spans two cafeteria plan years?

A-5: (a) Contributions to a cafeteria plan during FMLA leave will

not be included in an employee's gross income, provided that the plan

complies with all cafeteria plan requirements. Among other

requirements, a plan may not operate in a manner that enables employees

on FMLA leave to defer compensation from one cafeteria plan year to a

subsequent cafeteria plan year. See Prop. Treas. Reg. Sec. 1.125-2,

Q&A-5.\3\

\3\ Published as a proposed rule at 54 FR 9460 (March 7, 1989).

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(b) The following example illustrates this Q&A-5:

Example. Employee A elects health coverage under a calendar year

cafeteria plan maintained by Employer X. A's premium for health

coverage is $100 per month throughout the 12-month period of

coverage. A takes FMLA leave for 12 weeks beginning on October 31

after making 10 months worth of premiums totalling $1000 (10 months

x $100 = $1000). A maintains health coverage while on FMLA leave. A

utilizes the pre-pay option by cashing-out A's unused sick days in

order to make the required premium payments due while A is on FMLA

leave. Because A cannot defer compensation from one plan year to a

subsequent plan year, A may pre-pay the premiums due in November and

December (i.e., $100 per month) on a pre-tax basis, but A cannot

pre-pay the premium payment due in January on a pre-tax basis. If A

participates in the cafeteria plan in the subsequent plan year, A

must use another option (e.g., pay-as-you-go or catch-up) to make

the premium payment due in January.

Q-6: Are there special rules concerning employees taking FMLA leave

who participate in health FSAs offered under a cafeteria plan?

A-6: (a) In general. (1) A health plan that is a flexible spending

arrangement (FSA) offered under a cafeteria plan must conform to the

generally applicable rules in this section concerning employees who

take FMLA leave. Thus, FMLA requires that an employee taking FMLA leave

be permitted to--

(i) Continue coverage under a health FSA while on FMLA leave; or

(ii) Revoke an existing health FSA election under the cafeteria

plan for the remainder of the coverage period. See 29 CFR 825.209(e).

(2) FMLA also requires the plan to permit the employee to be

reinstated in the health FSA upon return from FMLA leave on the same

terms as prior to taking FMLA leave. See 29 CFR 825.215(d) and

paragraph (b)(2) of this Q&A-6. However, reinstatement is at the

employee's election and under no circumstances may an employer require

[[Page 66232]]

an employee whose coverage has terminated while on FMLA leave to

reinstate coverage under a health FSA upon return from FMLA leave. See

29 CFR 825.214(a).

(b) Uniform Coverage Rule (1) Q&A-7(b)(2) of Sec. 1.125-2\4\ (the

uniform coverage rule) applies during the FMLA leave period as long as

the employee continues health coverage. Therefore, regardless of the

payment option selected under Q&A-3 of this section, for so long as the

employee continues coverage (or for so long as the employer continues

the coverage of an employee who fails to make the required

contributions as described in Q&A-3(a)(2)(iii) of this section), the

full amount of the elected coverage, less any prior reimbursements,

must be available to the employee at all times, including the FMLA

leave period.

\4\ Published as a proposed rule at 54 FR 9460 (March 7, 1989).

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(2)(i) If an employee's coverage under the health FSA terminates

while the employee is on FMLA leave, the employee is not entitled to

receive reimbursements for claims incurred during the period when the

coverage is terminated. If that employee subsequently elects to be

reinstated in the health FSA upon return from FMLA leave for the

remainder of the plan year, the employee may not retroactively elect

health FSA coverage for claims incurred during the period when the

coverage was terminated. Further, the employee is not entitled to

greater FSA benefits relative to premiums paid than an employee who has

been continuously working during the plan year. See 29 CFR 825.216.

Therefore, if an employee elects to be reinstated in a health FSA upon

return from FMLA leave, the employee's coverage for the remainder of

the plan year is equal to the employee's election for the 12-month

period of coverage (or such shorter period as provided under

Sec. 1.125-2 \5\), prorated for the period during the FMLA leave for

which no premiums were paid, and reduced by prior reimbursements.

\5\ Published as a proposed rule at 54 FR 9460 (March 7, 1989).

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(ii) An employee on FMLA leave has the right to revoke or change

elections (e.g., because of changes in family status) under the same

terms and conditions that apply to employees participating in the

cafeteria plan who are not on FMLA leave. Thus, notwithstanding the

rules described in paragraph (b)(2)(i) of this Q&A-6, an employee who

returns from FMLA leave may make a new health FSA election for the

remainder of the plan year if return from leave without pay constitutes

a change of family status under the employer's cafeteria plan.

(3) The following examples illustrate the rules in this Q&A-6:

Example 1: (a) Employee A elects $1200 worth of coverage under a

calendar year health FSA provided under a cafeteria plan, with an

annual premium of $1200. A is permitted to pay the $1200 through

pre-tax salary reduction amounts of $100 per month throughout the

12-month period of coverage. A incurs no medical expenses prior to

April 1. On April 1, A takes FMLA leave after making three months

worth of contributions totalling $300 (3 months x $100 = $300).

The plan does not permit a revocation of election on account of a

change in family status. However, pursuant to A's rights under FMLA,

A elects to terminate coverage upon going on FMLA leave.

Consequently, A makes no premium payments for the months of April,

May, and June, and A is not entitled to submit claims or receive

reimbursements for expenses incurred during this period. A returns

from FMLA leave and elects to be reinstated in the health FSA on

July 1.

(b) Under FMLA, A has no greater right to benefits upon

reinstatement than if A had been continuously working during the

plan year. Therefore, A is reinstated to A's annual election (i.e.,

$1200) prorated for the period during the FMLA leave for which no

premiums were paid (i.e., reduced for 3 months or \1/4\ of the plan

year) less prior reimbursements (i.e., $0). Consequently, A's

coverage for the remainder of the plan year equals $900. A must also

begin making premium payments of $100 per month for the remainder of

the plan year.

Example 2: Assume the same facts as Example 1 except that A

incurs medical expenses totaling $200 in February and obtains

reimbursement of these expenses. The results are the same as in

Example 1, except that A's coverage for the remainder of the plan

year equals $700.

Example 3: Assume the same facts as Example 1 except that prior

to taking FMLA leave, A elects to continue health FSA coverage

during the FMLA leave. The plan permits A (and A elects) to use the

catch-up payment option described in Q&A-3 of this section, and as

further permitted under the plan, A chooses to repay the $300 in

missed payments on a ratable basis over the remaining six-month

period of coverage (i.e., $50 per month). Thus, A's monthly premium

payments for the remainder of the plan year will be $150 ($100 +

$50).

Q-7: Are employees entitled to non-health benefits while taking

FMLA leave?

A-7: FMLA does not require an employer to maintain an employee's

non-health benefits (e.g., life insurance) during FMLA leave. An

employee's entitlement to benefits other than group health benefits

under a cafeteria plan during a period of FMLA leave is to be

determined by the employer's established policy for providing such

benefits when the employee is on non-FMLA leave (paid or unpaid). See

29 CFR 825.209(h). Therefore, an employee who takes FMLA leave is

entitled to revoke an election of non-health benefits under a cafeteria

plan to the same extent employees taking non-FMLA leave are permitted

to revoke elections of non-health benefits under a cafeteria plan. For

example, election changes are permitted due to changes of family status

or upon enrollment for a new plan year. See Sec. 1.125-2, Q&A-6(c) \6\

and Sec. 1.125-1, Q&A-8.\7\ However, the FMLA regulations provide that,

in certain cases, an employer may continue an employee's non-health

benefits under the employer's cafeteria plan while the employee is on

FMLA leave to ensure that the employer can meet its responsibility to

provide equivalent benefits to the employee upon return from unpaid

FMLA. If the employer continues an employee's non-health benefits

during FMLA leave, the employer is entitled to recoup the costs

incurred for paying the employee's share of the premiums during the

FMLA leave period. See 29 CFR 825.213(b). In addition, a cafeteria plan

must, as required by FMLA, permit an employee whose coverage terminated

while on FMLA leave (either by revocation or nonpayment of premiums) to

be reinstated in the cafeteria plan on return from FMLA leave. See 29

CFR 825.214(a) and 825.215(d).

\6\ Published as a proposed rule at 54 FR 9460 (March 7, 1989).

\7\ Published as a proposed rule at 49 FR 19321 (May 7, 1984).

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Q-8: How may taxpayers rely on these proposed regulations?

A-8: (a) The guidance provided by the questions and answers in this

section may be relied upon to comply with provisions of section 125 and

will be applied by the Internal Revenue Service in resolving issues

arising under cafeteria plans and related Internal Revenue Code

sections. If final regulations are more restrictive than the guidance

in this section, the regulations will not be applied retroactively. No

inference, however, should be drawn regarding issues not expressly

raised that may be suggested by a particular question or answer or by

the inclusion or exclusion of certain questions.

(b) The Department of Labor has advised the Department of the

Treasury, including the Internal Revenue Service, that the provisions

of this section are not inconsistent with the provisions of

[[Page 66233]]

FMLA and the Labor Regulations thereunder.

Margaret Milner Richardson,

Commissioner of Internal Revenue.

[FR Doc. 95-30681 Filed 12-20-95; 8:45 am]

BILLING CODE 4830-01-U