Question: What are the differences in the election change rules between commuter benefits and FSA?
Compliance Team Response:
Section 132 Commuter Benefit Elections: May be Changed Monthly
The big difference between commuter benefits and FSAs is that the period of coverage for commuter benefits can be (and almost always is) limited to only one month. The only limitation on an employee changing a commuter benefit election is that it must be made before the next month’s period of coverage, and it must be irrevocable for that one-month period.
In other words, unlike FSAs, employees are not locked into an OE commuter benefits election for the duration of the plan year unless they experience a permitted election change event. Rather, employees can freely join, increase, decrease, or revoke commuter benefit elections each month for any reason. Those elections will be effective for the following month, and in most plans they will continue indefinitely until modified by the employee.
Section 125 Cafeteria Plan Election Rules: Irrevocable for the Plan year
The Section 125 rules apply to employee elections for the health FSA and dependent care FSA, as well as to pay the employee-share of the premium on a pre-tax basis for medical, dental, and vision coverage (POP).
That general rule under Section 125 for ongoing employees is that all elections (including an election not to participate) must be:
1) Made prior to the start of the plan year (i.e., during open enrollment), and
2) Irrevocable for the plan year unless the employee experiences a permitted election change event.
The permitted election change events are set forth in Treas. Reg. §1.125-4. The ABD Section 125 Cafeteria Plan Permitted Election Change Event Chart summarizes the life events that may create a permitted election change event once the plan year begins.
Treas. Reg. §1.132-9, Q/A-14:
(b) Timing of election. The compensation reduction election must be made before the employee is able currently to receive the cash or other taxable amount at the employee’s discretion. The determination of whether the employee is able currently to receive the cash does not depend on whether it has been constructively received for purposes of section 451. The election must specify that the period (such as a calendar month) for which the qualified transportation fringe will be provided must not begin before the election is made. Thus, a compensation reduction election must relate to qualified transportation fringes to be provided after the election. For this purpose, the date a qualified transportation fringe is provided is—
(1) The date the employee receives a voucher or similar item; or
(2) In any other case, the date the employee uses the qualified transportation fringe.
(c) Revocability of elections. The employee may not revoke a compensation reduction election after the employee is able currently to receive the cash or other taxable amount at the employee’s discretion. In addition, the election may not be revoked after the beginning of the period for which the qualified transportation fringe will be provided.
(e) Examples. The following examples illustrate the principles of this Q/A-14:
(i) Employer P maintains a qualified transportation fringe benefit arrangement during a year in which the statutory monthly limit is $100 for transportation in a commuter highway vehicle and transit passes (2002 or later) and $180 for qualified parking. Employees of P are paid cash compensation twice per month, with the payroll dates being the first and the fifteenth day of the month. Under P’s arrangement, an employee is permitted to elect at any time before the first day of a month to reduce his or her compensation payable during that month in an amount up to the applicable statutory monthly limit ($100 if the employee elects coverage for transportation in a commuter highway vehicle or a mass transit pass, or $180 if the employee chooses qualified parking) in return for the right to receive qualified transportation fringes up to the amount of the election. If such an election is made, P will provide a mass transit pass for that month with a value not exceeding the compensation reduction amount elected by the employee or will reimburse the cost of other qualified transportation fringes used by the employee on or after the first day of that month up to the compensation reduction amount elected by the employee. Any compensation reduction amount elected by the employee for the month that is not used for qualified transportation fringes is not refunded to the employee at any future date.
(ii) In this Example 1, the arrangement satisfies the requirements of this Q/A-14 because the election is made before the employee is able currently to receive the cash and the election specifies the future period for which the qualified transportation fringes will be provided. The arrangement would also satisfy the requirements of this Q/A-14 and Q/A-13 of this section if employees are allowed to elect to reduce compensation up to $280 per month ($100 plus $180).
Prop. Treas. Reg. §1.125-1(c)(7):
(7) Operational failure.
(i) In general. If the cafeteria plan fails to operate according to its written plan or otherwise fails to operate in compliance with section 125 and the regulations, the plan is not a cafeteria plan and employees’ elections between taxable and nontaxable benefits result in gross income to the employees.
(ii) Failure to operate according to written cafeteria plan or section 125. Examples of failures resulting in section 125 not applying to a plan include the following—
(A) Paying or reimbursing expenses for qualified benefits incurred before the later of the adoption date or effective date of the cafeteria plan, before the beginning of a period of coverage or before the later of the date of adoption or effective date of a plan amendment adding a new benefit;
(B) Offering benefits other than permitted taxable benefits and qualified benefits;
(C) Operating to defer compensation (except as permitted in paragraph (o) of this section);
(D) Failing to comply with the uniform coverage rule in paragraph (d) in §1.125-5;
(E) Failing to comply with the use-or-lose rule in paragraph (c) in §1.125-5;
(F) Allowing employees to revoke elections or make new elections, except as provided in §1.125-4 and paragraph (a) in §1.125-2;
(G) Failing to comply with the substantiation requirements of § 1.125-6;
(H) Paying or reimbursing expenses in an FSA other than expenses expressly permitted in paragraph (h) in §1.125-5;
(I) Allocating experience gains other than as expressly permitted in paragraph (o) in §1.125-5;
(J) Failing to comply with the grace period rules in paragraph (e) of this section; or
(K) Failing to comply with the qualified HSA distribution rules in paragraph (n) in §1.125-5.
Prop. Treas. Reg. §1.125-2(a):
(a) Rules relating to making and revoking elections.
(1) Elections in general. A plan is not a cafeteria plan unless the plan provides in writing that employees are permitted to make elections among the permitted taxable benefits and qualified benefits offered through the plan for the plan year (and grace period, if applicable). All elections must be irrevocable by the date described in paragraph (a)(2) of this section except as provided in paragraph (a)(4) of this section. An election is not irrevocable if, after the earlier of the dates specified in paragraph (a)(2) of this section, employees have the right to revoke their elections of qualified benefits and instead receive the taxable benefits for such period, without regard to whether the employees actually revoke their elections.
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