The IRS issued a ruling earlier this summer that serves as a reminder of how important it is to maintain the distinction between an election for health plan coverage and an election on how to pay for such coverage.
In practice, virtually all employees (and frankly, many employers) forget there is a distinction between electing coverage and electing how to pay for it. It is usually automatically assumed that when an employee elects medical coverage, they will pay for that coverage pre-tax under a Section 125 cafeteria plan. Indeed, IRS guidance and proposed regulations permit the employer to default an employee into paying for medical coverage pre-tax under a cafeteria plan. But if an employee makes this election (either affirmatively or by default), they may come to regret it, as demonstrated in the IRS Chief Counsel letter issued May 8, 2019.
The ruling was requested by an employee who had been covering an ex-spouse as a dependent under the employer’s medical plan, pursuant to a court order. When the ex-spouse died mid-year, the employee understandably wanted to stop paying for the coverage under the employer’s Section 125 plan. The IRS said no – that because the death of a former spouse is not one of the limited change in status events permitting changes in cafeteria plan elections (a former spouse is not a dependent), the employee could not change his election.
For employers, this is a reminder of the importance of keeping your employees’ medical plan coverage elections clearly defined and separate from their cafeteria plan elections. If you use a default or evergreen or other automatic election, make sure you communicate it obsessively so that employees won’t complain if they can’t get out of it later.