Correcting Cafeteria Plan Election Mistakes
4/13/2012 11:51 AM
Guest Contributor: Peter Antonie
An election for a cafeteria plan benefit can be corrected during the plan year in the context of a mistake if an employer can verify and confirm that a mistake was made in the election, either by the employer or employee.
Treasury Regulation 1.125-2 provides that a cafeteria plan election must be made in advance of the plan year, or eligibility date, and is irrevocable during the plan year. Treasury Regulation 1.125-4 provides 14 Permitted Election Change events for which an irrevocable election can be changed mid-year so long as the requested change is on account of the event and consistent with that event. Making a mistake in the election made is not a recognized Permitted Election Change event. However, IRS officials have offered guidance that, where there is clear and convincing evidence that an individual has made a mistake in an election or that the employer has made an administrative mistake in recording that election, the election can be undone, even retroactively.
Determining that an employer made a mistake is fairly straightforward – the employer would determine whether a clerical or administrative error occurred and go back to the time of the election and correct it. Examples of employer errors and the recommended correction would include:
- Entering the individual’s election in the wrong account – correct the mistake during the plan year by transferring the election to the correct account and closing the incorrect account
- Deducting too much or too little for the correct election – correct the mistake during the plan year by increasing the deduction to catch-up amounts not deducted or decreasing the deduction to “refund” dollars deducted in excess
Determining that an employee made a mistake is less straightforward. The employer would need to determine that an “impossible” election occurred or that a good faith mistake was made. Most often the request to correct the employee’s mistake involves an election for the wrong FSA.
An example of an impossible election would be an employee who elected the Dependent Care FSA but has no children that qualify for Dependent Care FSA reimbursement and there is no expectation that the funds would/could be used at anytime during the plan year. If the employee has no children, the employer would likely determine that this was an impossible election, especially if the employee has always had a Health Care FSA in the past. The correction would be transfer of the election from one account to the other and revoke the incorrect account.
But, what if the employee has children or is expecting a child that would qualify for reimbursement of day care expenses at sometime in the year. For example, an employee who made an election for the Dependent Care FSA at the start of the year in anticipation of the birth of a child or placement of a child in day care later in the year and then determines that the child will not be placed in day care did not make a “mistake.” In this case there is no correction warranted. The employee made an election in anticipation of a future expense, just like anticipating an expense in the Health Care FSA that does not materialize. Unless a Permitted Election Change event occurs allowing a change in the election, the employee is likely to forfeit money at the end of the plan year.
An example of a good faith mistake would be an employee who elects the Dependent Care FSA, did not have a Dependent Care FSA in the past but had a Health Care FSA election in the past and requests the employer transfer the election to the Health Care FSA due to filling out the election incorrectly. The correction is to transfer the funds from the Dependent Care FSA to the Health Care FSA and revoke (close) the DC FSA retroactive to the start of the plan year.
Another example of a good faith mistake would be an employee who has no children who qualify or could qualify for day care expense reimbursement and thought the Dependent Care FSA was for the medical expenses of the dependents. This good faith mistake can be corrected by transferring the election to the Health Care FSA.
Finally, correcting a mistake for the Health Care FSA is even more problematic, since it is unlikely that an employee made an impossible election – the funds can be used by at least the employee. More likely, the employee anticipated some medical expense that now won’t be incurred. However, the employee could have made a good faith mistake, such as electing the wrong FSA – has always had a DC FSA and no HC FSA in the past. Or, made an election for $2,000 and had a HC FSA of $200 in the past or vice versa . Again, if the employer determines that a mistake was made, the funds could be transferred from one account to the other or the HC FSA account election could be reduced or increased.
The Bottom Line: Unless the employer determines that a mistake was made in an election and corrects the mistake during the plan year, the employee must experience a Permitted Election Change event and request a change in the election at that time that is on account of the event and consistent with the event. Otherwise, no change in the election is allowed.