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Core Documents | Section 125 Plans, Wrap SPD, HRA Employer Plan Documents

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Section 125 COVID-19 relief: IRS on 2020 mid-year elections, FSA claims

The latest guidance from the Internal Revenue Service allows employer-sponsors of Section 125 cafeteria plans to permit mid-year changes to group health insurance, health FSA, and dependent care FSA elections. Plans may also extend grace periods on FSAs to cover eligible expenses through December 31, 2020. Learn how this new Section 125 COVID-19 relief can impact your Section 125 group health plan.

The IRS continues to provide Section 125 COVID-19 relief to taxpayers by allowing employers to amend cafeteria plans to better meet families’ health coverage needs during the pandemic.

Section 125 COVID-19 relief to employers

Notice 2020-29 addresses requests from employer-sponsors of Section 125 cafeteria plans for relief needed to respond to their employees’ changing needs as a result of the COVID-19 pandemic. It allows employers to amend terms of a plan to allow mid-year elections for group health insurance, health FSAs, and dependent care FSAs.

Usually, Section 125 plan elections are made at the start of a plan year and cannot be changed for the duration of the year unless an employee or eligible dependent experiences a qualifying life event that opens a special enrollment period for them.

In 2020, the whole country is experiencing a shared qualifying life event as the coronavirus emergency wreaks havoc on our health and finances. That is why the Departments of the Treasury, Health & Human Services, and Labor (the Departments) are granting employer-sponsors of group health plans and flexible spending arrangements relief to change the terms of their plans for a Section 125 COVID-19 limited special enrollment for all employees.

Plan year vs. calendar year

Section 125 COVID-19 relief applies to elections made for the 2020 calendar year. Plans with a non-calendar year will allow mid-year elections through December 31, 2020. For example, if your plan year runs from April 1, 2020, through March 31, 2021, it will allow mid-year changes to elections through December 31, 2020, only.

Employer options

Employers may add all, some, or none of the Section 125 COVID-19 relief options to their group plans. All changes made by an employee’s mid-year elections are made on a prospective basis, effective from the date of the mid-year election to the end of the 2020 calendar year.

Plan amendment required

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What does ADP charge for a Section 125 Premium Only Plan or POP?

ADP payroll clients have reported paying up to $425 per year plus an initial setup fee of up to $250 for ADP Section 125 POP administration. Many ADP clients are extremely happy to learn they can save $425 every year by purchasing and administering their own Section 125 POP.

What is a Section 125 Premium Only Plan?

A Section 125 Premium Only Plan (POP) allows employees to pre-tax insurance premium such as group health and dental, vision, accident, term life insurance, disability, etc.  Employees save up to 40% in payroll taxes and the employer save 7.65% in matching FICA taxes.

ADP Section 125 Fee $425 Every Year

ADP payroll clients have reported paying up to $425 per year plus an initial setup fee of up to $250 for ADP Section 125 POP administration. Many ADP clients are extremely happy to learn they can save that $425 every year by purchasing and administering their own Section 125 POP for just a $99 one-time fee*.

ADP will still deduct your employee's qualifying group health and supplemental insurance premium. Those employee pre-tax premium deductions remain in the employer’s general asset checking account until needed to pay insurance carrier invoices.

Nothing really changes; ADP still has to designate each employee's insurance premium deductions as “pre-tax” instead of “post-tax”, (by checking a box) in their payroll software.  This is what ADP refers to as Section 125 “administration”, checking the "pre-tax" box when the original deduction is entered, plus an annual non-discrimination test when requested.

Save $425 Every Year and do your own Non-Discrimination Testing

The $99 one-time fee for the Section 125 Premium Only Plan from CoreDocuments.com comes with employer non-discrimination annual test forms. In just a few minutes any employer can conduct their own non-discrimination testing and save $425 a year.

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Fringe Benefit Taxation and Section 125, HRA, HSA Plans for Owners and Employees

Fringe Benefit Taxation for Owners and Employees

Tax Savings with Section 125, HRA, and HSA Plans

A fringe benefit is non-monetary compensation for work. Fringe benefits can be provided by the business to employees, independent contractors, partners, and even to the owners.

Some fringe benefits are taxable to the recipient, but many have tax advantages over monetary compensation. Fringe benefits can be tax-free or partly tax-free, or they can defer taxes. Some fringe benefits, such as for health insurance, can even be free of employment taxes. Some fringe benefits can also offer reduced costs even if they are taxable, by taking advantage of group rates, such as life insurance that has a benefit greater than $50,000.

Fringe benefit taxation also depends on the business entity providing them. Owners of a sole proprietorship or a pass-through entity, including 2% shareholders of S corporations, are not considered employees, so they can receive benefits, but they do not have the tax advantages that they may have for rank-and-file employees.

While tax advantaged fringe benefits can be offered by a sole proprietorship, partnership, limited liability company, or S corporation to its employees, a C corporation can offer several more benefits that have tax advantages that are not available to the other entities. Moreover, owners of a C corporation can receive the same benefits with the same tax advantages that can be offered to the rank-and-file employees. Fringe benefits include:

financial and tax planning,

disability insurance and payments,

group life insurance,

loans to shareholders,

stock options,

employee stock ownership plans,

special commuter vehicles, which corporations provide     for commuting transportation for its employees and only if the vehicle is     used at least 80% of the time for commuting employees; and

the operating costs for corporate owned entertainment     facilities for the time that the facilities are used solely for business.

Taxable fringe benefits are reported on the employees' Form W-2, Wage and Tax Statement, which is usually issued at the end of the calendar year. Although independent contractors who perform services for the business can also be paid with fringe benefits, it is not common practice. If they are compensated with taxable fringe benefits, then they will be reported on Form 1099-MISC, Miscellaneous Income. Partners may also receive taxable fringe benefits, which are reported on Schedule K-1 (Form 1065), Partner Share of Income, Deductions, Credits, etc. Tax-free fringe benefits are generally not reported.

One key advantage of compensating employees with fringe benefits is that the most common benefits are taxed at a lower rate than monetary compensation — some are not taxed at all. Otherwise, fringe benefit taxation applies unless they satisfy the following requirements, where the fringe benefit must:

be specifically excluded from taxation by the     tax code,

be provided in writing, which is usually     accomplished through an employee benefit plan, and

have no definite term length, such as for a     specific amount of time or if an employee reaches a certain age.

Sometimes only a certain amount is excluded, so any benefit with a greater value than the excludable amount is taxable. If the employee pays for the benefit, then the payment amount is specifically deductible against the taxable amount under the return of capital doctrine. Some benefits to owner-employees are limited to a percentage paid to rank-and-file employees. Owner-employees with respect to fringe benefits are those who own more than 5% of the business.

For those benefits that are specifically excluded from taxation by law, all are excluded from income taxes, but a few are also excluded from Social Security and Medicare (FICA) taxes, and some are also excluded from unemployment (FUTA) taxes if they are employees:

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Section 105 Plan Explained

Section 105 of the Internal Revenue Code allows employers to establish a written plan to reimburse medical expenses. There are numerous variations of the Section 105 plan including: Health Reimbursement Arrangements (HRAs), Medical Expense Reimbursement Plans (MERPs), Health Flexible Spending Arrangements (FSAs), Accident and Health Plans (both insured and self-insured), and more.

Core Documents specializes in the FSA and HRA variations, and the one-person 105 HRA form of Section 105 of the Code. See:    www.Core105.com

Section 105 Plan as it pertains to an Accident and Health Plan

The IRS affords for an Accident and Health Plan pursuant to Section 105 of the Code. This type of plan encompasses Revenue Ruling 71-588, is supported by Letter Ruling 9409006, and meets the compliance regulations of other government agencies including the Department of Labor (DOL) and the Employee Retirement Income Security Act (ERISA).

The concepts surrounding both the rulings and the Code allow for a self-employed individual to employ his/her spouse who is active in the business, and to offer that employed-spouse a medical benefits package. The benefits offered cover the employee, the employee’s spouse, and the employee's dependents.

In reality, this allows the self-employed individual to deduct 100% of his/her family's health costs from federal, state, and FICA/Medicare taxes. Standard tax law allows healthcare premiums to be deducted at 100% from federal and state taxes, leaving a substantial amount of potential tax savings on the table.

Benefits of the Plan

A Section 105 Plan allows a qualified business owner to deduct 100% of

Health     insurance and dental insurance premiums for eligible employee(s) and     family. This also includes qualified long-term care insurance.

Uninsured     (out-of-pocket) medical, dental, and vision care expenses for eligible     employee(s) and family.

Life,     disability income, contact lens, hearing aid, Medicare Part A, Medicare     Supplemental, optical/vision, and cancer insurance premiums for eligible     employee(s).

Qualified Filing Statuses

While the above rulings specifically address family employment in a sole proprietorship, corporations and partnerships may also take advantage of a Section 105 Plan. Additionally, employers seeking to offer non-related employees a medical benefits package may also implement such a plan. Here is how a Section 105 Plan works within the various filing statuses.

Sole Proprietorships

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Two Ways Employers Contribute to Employee HSA Savings and Nondiscrimination Testing

HSA Tax Benefits

All employer contributions to employee HSAs are made on a “pre-tax” basis. Employers may make pre-tax contributions to their employees’ HSAs either through a Section 125 plan or through a direct contribution. Contributions can be made in one lump sum or in payments throughout the year. Deposited funds belong to the employee. The combination of employer and employee contributions cannot exceed the IRS annual maximums.

Direct Employer Contributions (outside a Section 125 Plan)

Full-time      versus part-time

 Self      only, self plus one, self plus two, or self plus three or more

 HSA-eligible      versus non-eligible

An exception to the comparability rules allows employers to contribute more to the HSAs of non-highly compensated individuals. For this purpose, the definition of "highly compensated employee" is based on the same definition used for qualified retirement plans.

Failure to comply with these rules may result in a 35 percent penalty, so employers are encouraged to consult their tax adviser or legal counsel to make sure they comply with these rules.

Employers     are not allowed to take an additional deduction for the payroll taxes     (Social Security tax, Medicare tax and FUTA) associated with employee     “post-tax” contributions.

Employer Contributions through a Section 125 Plan

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Can an HRA pay Medicare premiums for employees?

Increasingly, employees working through the gap between Medicare and Social Security eligibility ask an employer to cover Medicare supplemental premiums in lieu of a traditional group health plan. Can a company's HRA pay Medicare premiums for employees?

The official Social Security “retirement age” is rising thanks to the effects of the Social Security Amendments of 1983. By 2027, it will go to 67 years old. Plus, there is a bonus for people delaying their Social Security benefit – as much as 32% more for a person born in 1950 who begins taking their benefit at age 70.

Yet, the age to qualify for Medicare remains at 65 years old. This difference in eligibility age means more people are working while under Medicare coverage.

Increasingly, employees working through this gap ask if they can refuse an employer's group health plan (GHP) and have their Medicare supplemental premiums reimbursed through the Health Reimbursement Arrangement (HRA) instead.   An employer needs to know when they can or cannot let the company's HRA pay Medicare premiums in order to remain in compliance with Medicare rules, the Affordable Care Act (ACA) and tax laws.

Can an HRA pay Medicare premiums for employees?

For an employer-sponsored GHP with 20 or more employees, the answer is no. It is not permitted under Medicare Secondary Payer (MSP) rules.

IRS, ACA, and DOL Rules

At first, reading the rules for employer payment of premiums under the Internal Revenue Service, Affordable Care Act, and Department of Labor, there seems to be no prohibition against employers having an HRA pay Medicare premiums the traditional GHP premium. That's as long as employers do not encourage or force employees to leave the GHP for Medicare (so that the employer can save money with lower premiums).

And there, the IRS refers employers to MSP rules.

Medicare Secondary Payer (MSP) Rules

MSP rules determine which coverage pays first when a person is covered by both Medicare and a GHP. The goal is to strike a balance to protect both small-group employers and Medicare.

To make this happen, MSP rules say that when an employer group is small (less than 20), Medicare is always the primary payer and private insurance always pays as secondary.

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Can an HRA pay Medicare premiums for employees?

Increasingly, employees working through the gap between Medicare and Social Security eligibility ask an employer to cover Medicare supplemental premiums in lieu of a traditional group health plan. Can a company's HRA pay Medicare premiums for employees?

The official Social Security “retirement age” is rising thanks to the effects of the Social Security Amendments of 1983. By 2027, it will go to 67 years old. Plus, there is a bonus for people delaying their Social Security benefit – as much as 32% more for a person born in 1950 who begins taking their benefit at age 70.

Yet, the age to qualify for Medicare remains at 65 years old. This difference in eligibility age means more people are working while under Medicare coverage.

Increasingly, employees working through this gap ask if they can refuse an employer's group health plan (GHP) and have their Medicare supplemental premiums reimbursed through the Health Reimbursement Arrangement (HRA) instead.   An employer needs to know when they can or cannot let the company's HRA pay Medicare premiums in order to remain in compliance with Medicare rules, the Affordable Care Act (ACA) and tax laws.

Can an HRA pay Medicare premiums for employees?

For an employer-sponsored GHP with 20 or more employees, the answer is no. It is not permitted under Medicare Secondary Payer (MSP) rules.

IRS, ACA, and DOL Rules

At first, reading the rules for employer payment of premiums under the Internal Revenue Service, Affordable Care Act, and Department of Labor, there seems to be no prohibition against employers having an HRA pay Medicare premiums the traditional GHP premium. That's as long as employers do not encourage or force employees to leave the GHP for Medicare (so that the employer can save money with lower premiums).

And there, the IRS refers employers to MSP rules.

Medicare Secondary Payer (MSP) Rules

MSP rules determine which coverage pays first when a person is covered by both Medicare and a GHP. The goal is to strike a balance to protect both small-group employers and Medicare.

To make this happen, MSP rules say that when an employer group is small (less than 20), Medicare is always the primary payer and private insurance always pays as secondary.

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IRS Section 125 Tax Code

IRS Section 125 Tax Code

IRS Section 125 Code Cafeteria Plan Documents are one of the most underused employee benefits for small businesses. These plans allow employees to pay tax-free premiums for group health insurance and other qualified benefits (such as group term life, accident, long-term care, and dread disease coverage), medical expenses, and dependent care expenses.

IRS Code 125 benefits

Because Section 125 Cafeteria Plan benefits are exempt from federal and state income tax, an employee's taxable income is reduced which increases take-home pay. And, because the Section 125 Cafeteria Plan reduces employee gross income, the employer also sees a reduction in payroll tax liability by eliminating matching FICA taxes of 7.65%, and possibly workers' compensation as well (depending on your state).

IRS Section 125 Code

a) General Rule. Except as provided in Subsection (b), no amount shall be included in the gross income of a participant in a IRS Section 125 Cafeteria Plan solely because, under the Plan, the participant may choose among the benefits of the Plan.

(b) Exception For Highly Compensated Participants. (1) Highly Compensated Participants.

In the case of a highly compensated participant, Subsection (a) shall not apply to any benefit attributable to an IRS Section 125 Plan Year for which the Plan discriminates in favor of

(A) highly compensated individuals as to eligibility to participate, or

(B) highly compensated participants as to contributions and benefits.

(2) Key Employees.

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Section 125 Plan Document Requirement

The Section 125 Plan allows employees to pay for health insurance and other eligible benefits with pre-tax dollars. Essentially, the employer offers employees the opportunity to agree to a salary deduction in exchange for the benefits. This reduces the employee's taxable income, in effect making the health insurance and other eligible benefits tax free. Employers save, too, by reducing the overall payroll base on which FICA and other payroll taxes are calculated. Just be sure to meet the Section 125 plan document requirement so that your company's tax-free benefits plan is IRS-, DOL-, and ACA-compliant.

Section 125 Plan Document Requirement

IRS Code, Section 125 (d) (1), sets the Section 125 plan document requirement for employers offering the option of paying for health insurance and other benefits with a pre-tax salary deduction. Here is some basic information about the plan document:

A Section     125 plan document contains all information on the plan, including     eligibility rules, benefits available, plan trustee(s) and     administrator(s), and more, as needed, to properly describe the Section     125 plan in full.

The     required plan document must be in place before the first day of the plan     year, when the benefits are available to employees.

A copy of     the Summary Plan Description (SPD) part of the plan must be distributed to     every employee eligible to participate in the plan prior to the start of     each plan year.

The     Section 125 plan document requirement does not include filing the document     with any government agency, only to keep it on file and available for     employee requests or in the case of an audit.

Getting your plan document

There are no rules that say you cannot do it yourself -- if you have the knowledge of benefit and tax law to do it.

You may also find a do-it-yourself template or checklist online, although this also requires some knowledge of benefit and tax law to make sure the template actually fits your company's benefit plan. Beware of companies requiring an annual subscription or renewal fee.

The best way to do it, of course, is to partner with a group having more than 20 years' experience helping thousands of employers meet the Section 125 plan document requirement.

Core 125

Core Documents provides employers with everything they need to meet the Section 125 plan document requirement to establish an IRS- and DOL-compliant Section 125 cafeteria plan in PDF format for just $99. This cost reflects a one-time setup fee, not an annual charge. For an additional $50, employers can choose the Deluxe Binder option that includes the PDF email version plus a printed plan document in a 3-ring binder.

Your plan document only needs an update when there are changes in your plan or the law governing health plans that make it necessary. You let us know about changes in your plan, and we let you know about changes in the law. Otherwise, your Core 125 plan document is durable for several years.

Download now:

Core Section 125 POP Premium Only Plan Document & Forms

Setting up the plan

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How to report QSEHRA benefits on IRS Form W-2 (with exceptions)

The IRS requires employers to report QSEHRA benefits available to employees on Form W-2. This amount must be reported on every employee's IRS Form W-2 whether or not the employee receives reimbursement from the QSEHRA; reporting will not have an effect on the employee's taxable income either way.

How to report QSEHRA benefits on Form W-2

The Qualified Small Employer Health Reimbursement Arrangement (QSEHRA) is a fairly new HRA plan design, available to employers since December 2016. With a QSEHRA, employers with fewer than 50 full-time employees can provide funds to help employees buy individual health insurance with pre-tax dollars, as long as the employer provides no group health plan to any active employee group.

Recent guidance (Notice 2017-67) provides details on the basics for reporting QSEHRA benefits on Form W-2, plus how to report variances that can come up in some employee-employer situations.

Standard Permitted Benefits in QSEHRA

The entire amount of the QSE-HRA benefit available to the employee must be reported on Form W-2 whether or not the employee uses it.

This amount is reported in box 12, using code FF. This is a new code especially for the QSE-HRA benefit amount available to the employee. The IRS description for it is, "Permitted benefits under a qualified small employer health reimbursement arrangement." It is not counted as taxable income for the employee.

Over-the-Counter Medical Expenses

An employer may choose to allow reimbursement of over-the-counter medical expenses (eligible per Publication 502) through the QSEHRA. When this option is made available to employees, records must be kept for year-end W-2 reporting.

When an employee receives reimbursement from the QSEHRA for over-the-counter drugs:

The     amount is reported on Form W-2 as income in box 1 as well as box 3, Social Security wages,     and box 5, Medicare wages.

Non-Calendar Plan Years

When a QSEHRA is run on a non-calendar plan year, the amount reported on Form W-2 is pro-rated accordingly.

For example, an employer provides a QSEHRA with a plan year of July 1 to June 30:

For the plan year beginning July 1, 2017, a QSEHRA benefit of $4,000 was available to every employee for July 1, 2017 through June 30, 2018. The amount reported on the employee's 2017 Form W-2, box 12, code FF is $2,000 (for July-December 2017).

In the new plan year (2018), the QSEHRA provides $4,500 to every employee for July 1, 2018 through June 30, 2019. The amount reported on the employee's 2018 Form W-2, box 12, code FF is $4,250 ($2,000 for January-June 2018, and $2,250 for July-December 2018).

Carryover Provisions

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Health Insurance for S Corporation 2% Shareholders

The cost of health insurance premiums paid by an employer is usually excluded from taxable income on the employee’s W-2. A more than 2% shareholder of an S corporation is not eligible for this exclusion.

However, with health Insurance for S Corporation 2% shareholders, the 2% shareholder may be able to deduct the cost of the premiums on his Form 1040.

What is a 2% shareholder?

A “2% shareholder” is an S corporation shareholder who owns, directly or indirectly, more than 2% of the stock of the corporation on any day during the tax year.

Indirect ownership – family attribution rules

The following family members of a shareholder are treated as owning a shareholder’s stock for this purpose:

Spouse

Children

Grandchildren

Parents

Example 1

Karen sells her entire 10% interest in Flagco (a calendar year S corporation) on January 2, 2013. She continues to work at Flagco and receives health insurance through the company. Karen is a 2% shareholder of Flagco for 2013 because she owned more than 2% of Flagco’s stock on at least one day (January 1) in 2013.

Example 2

Justin is an employee of Flagco and receives health insurance through the company. He owns no Flagco stock. However, his father Jerry owns 75% of Flagco’s stock. Justin is a 2% shareholder of Flagco because he is deemed to own 75% of Flagco’s stock through the family attribution rules.

Tax treatment by the company

Health Insurance for S Corporation 2% Shareholders: Reporting to the shareholder

The cost of health insurance premiums paid by the S corporation for a 2% shareholder is included in the shareholder’s W-2 as Box 1 taxable income. The amount is subject to federal income tax withholding. It is not subject to FICA and FUTA taxes if the payments are made under a plan for employees generally or for a class (or classes) of employees. There is no definition of a class of employees, and there is no requirement that the class not be discriminatory. A plan normally exists if any one of the following applies:

The plan is in writing or is otherwise made known to employees,

There is reference to the plan in the employment contract,

Employees contribute to the plan,

There is a separate fund for payments apart from the employer's salary account, or

The employer is required to make the payments.

If any one of these applies, the benefits are not subject to FICA and FUTA taxes and are not included in Box 3 or Box 5 of the W-2.

Deduction by the company

The S corporation can deduct the cost of health premiums paid for 2% shareholders on its Form 1120S income tax return. Since the premiums are treated as additional compensation to the shareholders, the deduction should be taken on page 1, Line 7 (Compensation of officers) or Line 8 (Salaries and wages). This reduces the net income (or increases the loss) which passes through to the shareholders on Schedule K-1. The deduction passes through proportionately to all owners. It cannot be specially allocated to the person who receives the income on Form W-2.

Tax treatment by the 2% shareholder

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How to find the Plan ID number for your benefit plan

The Plan ID is a 3-digit number used by the DOL, IRS, and ERISA to identify one employee welfare plan from another of a company’s benefit offerings. The Plan ID is used on all of our Plan Document Packages, including the ERISA Wrap Summary Plan Description.  Companies with 100+ employees will also need it for their Form 5500 filing.

Every benefit plan has one

Prior to gathering the information needed to order a Core 125 or other plan document package, most employers probably did not know they had or needed a Plan ID. What follows is a brief explanation of what the Plan ID is, where you find one, how to know when to retire one, and how it fits into the full plan number.

Finding the Plan ID

The Plan ID is a 3-digit number that designates one plan from another for the IRS and DOL. Which number goes to what plan is up to the employer in most cases.

In the instructions for Form 5500, the IRS informs us that Plan ID numbers are to begin with 501 for a company’s first health & welfare plan. The second plan is to be numbered 502, a third numbered 503, and so forth. This numbering system continues for as many plans as a company has over its lifetime with only two numbers disallowed: 888 and 999.

Here is an example of how an employer might number the different plans a company provides for employees:

Employer  Benefit Plan                                            Plan ID No. 

Section 125 Cafeteria Plan                                             501

Health Reimbursement Arrangement                             502

ERISA Wrap SPD                                                           503

Every company offering a group health plan should have at least two Plan ID numbers active: 501 for the main group health plan (Section 125 or HRA), and 502 for the required ERISA Wrap SPD.

Retiring a Plan ID

A plan retains its Plan ID number for the life of the plan. When changes are made to the plan, the Plan ID does not change. When a plan is retired, however, its Plan ID is, too. That Plan ID number cannot be used for another benefit plan.

For example, a company has offered a Section 125 Cafeteria plan for ten years under Plan ID 501. This year, the employer is changing to a Deductible Gap HRA. The new plan cannot be given Plan ID 501. It will be Plan ID 502. Plan ID 501 will be permanently retired for this employer.

Full Plan Number

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Can employers add to employee Health FSA contribution?

Employer Health FSA contributions drive goodwill, better health security for employees, and bigger tax savings for both. Learn more about employer options in matching contribution methods.

Employee contributions

A Health FSA is a part of an employer's Section 125 plan that allows employees to set aside pre-tax dollars to pay for out-of-pocket medical expenses. During the employer's open enrollment period each year, every employee determines how much to set aside for the health FSA contribution by estimating eligible out-of-pocket medical expenses throughout the plan year. That amount is then divided into every pay period as a pre-tax salary reduction.

Employer sets Health FSA rules

Employees decide how much they need in a Health FSA, but when it comes to how FSA contributions are managed, the employer sets all the rules, including:

While the IRS 2020 pre-tax maximum* for employee Health FSA contributions is $2,750, an employer may limit its employees to less than $2,750.

The employer also decides the provision for any unused Health FSA balance at the end of the year (grace period, partial roll-over, or surrender).

And, it is up to the employer whether or not to contribute to their employees’ Health FSA.

*The annual limit is usually adjusted upward for inflation each year.

Employer Contribution Amounts

The IRS puts a limit on an employer's contribution to the Health FSA based on how much the employee contributes:

An employer may match up to $500 whether or not the employee contributes to a Health FSA.

Starting at $501, however, employers may only make a dollar-for-dollar match to the employee's contribution.

Employer Contribution Methods

Defined Contribution

Many employers contribute a set amount to all employees’ Health FSAs, even if the employee does not contribute at all.

The following table shows three common scenarios under the defined contribution method.

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Do you need a Section 125  Plan Document? Get one today!

IRS Requirement for pre-taxed employee benefits

If you are an employer wanting to allow your employees to pay group health and other insurance premiums with pre-tax salary deductions, the answer is yes, you need a Section 125 plan document.

In most employer-sponsored group benefit plans, employees pay for health insurance and other qualified benefits with tax-free dollars. It's just taken for granted; that's the way it's done.

However, that tax-advantaged treatment is not automatic. The employer must do it through a Premium-Only Plan (POP) or Cafeteria plan, and to set up one of those, you need a Section 125 plan document.

Tax savings for everyone with a plan document

A Section 125 Premium Only Plan document allows your employees to voluntarily agree to a "salary reduction" so that the employer can pay their insurance premium as a business expense.

The portion of the insurance premium the employee is responsible for is deducted right off the top of income before taxes are calculated. This saves the employee $ .25 to $ .40 on every dollar paid in insurance premiums.

Employers also realize tax savings from reduced matching FICA, FUTA, SUTA, and Worker's Compensation taxes on all tax-advantaged employee funds.

This tax savings usually more than covers the costs associated with setting up a plan and administering it. Plus, employees are happy because they experience a "raise" when withholding tax is lowered.

A Section 125 (POP or Cafeteria) plan is "a written plan"

Section 125 is part of the U. S. Code where the Treasury (IRS) lays out the rules for employers wanting to allow employees the option of pre-tax salary deductions to pay group health and related insurance premiums.

The formal definition of a Section 125 plan to pre-tax benefits says:

Section 125 (d) Cafeteria plan defined

For purposes of this section—

(1) In general

The term “cafeteria plan” means a written plan under which—

(A) all participants are employees, and

(B) the participants may choose among 2 or more benefits consisting of cash and qualified benefits.

Understanding "qualified benefits"

Qualified benefits are defined as "not includible in the gross income of the employee" (ref. Section 125(f)). In other words, the premiums are tax-free within a POP or Cafeteria plan.

Those benefits include group health insurance and supplemental benefits, such as group term life insurance, disease-specific insurance, accidental death insurance, and others.

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Health FSA-eligible items: OTC products (with and without a prescription)

Every year, millions of people abandon tax-free dollars in a Health FSA when funds go unused at the end of the year. Often, these are resources a household really can’t afford to lose, but what can you do? Well, you can stock up on Health FSA-eligible items like contact lenses, sunscreen, nasal spray, lip balm, eyedrops, first aid supplies, and so much more.

A Health Flexible Spending Arrangement (Health FSA) is a Section 125 Cafeteria plan group health benefit that allows employees and employers to contribute funds that the employee (and dependents) can use to pay eligible medical expenses with tax-free dollars.  

Every year, millions of people abandon tax-free dollars in a Health FSA because the funds go unused. Often, these are resources a household really can’t afford to lose, but what can you do?

Well, you can stock up on Health FSA-eligible items like contact lenses, sunscreen, nasal spray, lip balm, eyedrops, first aid supplies, and so much more.

In fact, if people knew just how flexible a Health FSA is when it comes to what it can buy, very few of us would have a surrendered balance. That’s because good health isn’t only about prescriptions, co-pays, and deductibles, but wellness in general. And that means using those funds to make more general health purchases all through the year.

Which OTC products are Health FSA-eligible items?

Here’s a list of Health FSA-eligible items you can buy without a prescription:

Acne light therapy

Athletic and orthopedic braces and supports

Breast pumps and accessories

Blood glucose monitors and testing strips

Blood pressure monitors

Condoms

Contact lenses and supplies

Denture cream and cleansers

Eye drops

First aid supplies and kits

Glucosamine supplements

Hot and cold packs

Incontinence products

Lip balm

Motion sickness aids

Nasal spray

Pregnancy and fertility tests

Prenatal vitamins

Reading glasses

Shoe insoles and inserts

Sunscreens with SPF ratings of 15 and above

Thermometers

Vaporizers and inhalers

Walking aids and wheelchairs

NEW for 2020: CARES Act repeals "Medicine Cabinet Tax" on OTC reimbursements and expands items eligible for coverage

The Coronavirus Aid, Relief, and Economic Security (CARES) act removes the requirement for a physician's prescription for many over-the-counter items eligible for Health FSA, HSA, and HRA coverage, while expanding the list of eligible items and providing safe harbor to HDHPs associated with an HSA to cover pre-deductible telehealth and other remote care services. Read, Coronavirus “CARES Act” restores OTC coverage for FSAs, HRAs, HSAs to learn more.

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