On June 17, 2008, then-President Bush signed the Heroes Earnings Assistance and Tax Relief Act of 2008 (also known as the HEART Act). Among other changes created by the HEART Act (including changes in retirement plan administration), the law may impact the way in which employers administer health flexible spending arrangements, eliminating the “use-it-or-lose-it” rule for qualifying employees who are called to active duty.
If an employer offers a health flexible spending arrangement, the employer may (but is not required to) amend its cafeteria plan to allow for a “qualified reservist distribution (QRD).” A QRD is any distribution to an individual of all or a portion of the balance remaining in the employee’s health flexible spending account when that individual is called to active duty. With this change, individuals called to active duty will not have to forfeit any unused balances in their health flexible spending arrangements. To qualify for a qualified reservist distribution, the following four requirements must be met:
- A qualified reservist distribution can be made only to a member of a "reserve component" (as defined in section 101 of title 37 of the United States Code). This means a member of the Army National Guard; U.S. Army, Navy, Marine Corps, Air Force, or Coast Guard Reserve; Air National Guard of the United States; or the Reserve Corps of the Public Health Service.
- The distributions can be made only to a reservist who has been ordered or called into active duty for (i) 180 days or more, or (ii) for an indefinite period.
- The amount of the distribution must be for "all or a portion of the balance in the employee's account."
- The distribution must be made within the period beginning on the date the reservist is called or ordered to duty and ending on the last day that reimbursements could otherwise be made for the plan year that includes the first day of the distribution period.
To implement this option, the employer should amend its cafeteria plan. Cafeteria plan amendments must be made prospectively.
There were several questions raised by the HEART Act and the IRS issued additional guidance on the HEART Act and those questions, along with the answers, which are outlined for your information below:
Q: How does the HEART Act define “account balance”? Is it the aggregate amount contributed by the employee minus reimbursements or the annual election amount minus reimbursements?
A: The IRS provided guidance on what amounts can be distributed, and it appears that employers have some flexibility in deciding – they can distribute just the amount that has been contributed, but not paid out in reimbursements, or the election amount less what has been paid out in reimbursements – but whatever the employer decides, it should be stated clearly in the cafeteria plan document amendment. “The IRS guidance says:
- The cafeteria plan may provide that the amount available as a QRD will be:
- The entire amount elected for the health FSA for the plan year minus health FSA reimbursements received as of the date of the QRD request;
- The amount contributed to the health FSA as of the date of the QRD request minus health FSA reimbursements received as of the date of the QRD request; or
- Some other amount (not exceeding the entire amount elected for the health FSA for the plan year minus reimbursements).
If the cafeteria plan amendment does not indicate how the plan will determine the amount available as a QRD, then the amount available shall be the amount contributed to the health FSA as of the date of the QRD request minus health FSA reimbursements received as of the date of the QRD request.“
Q: Would the QRD be reported on the reservist W-2 as income since it’s being distributed as cash? If so, should it be subject to withholding?
A: Yes, it is reported as income on the W-2. The IRS guidance says: “A QRD is included in the gross income and wages of the employee, and is subject to employment taxes. The employer must report the QRD as wages on the employee’s Form W-2 for the year in which the QRD is paid to the employee. The amount reported as wages is reduced by any amount in the health FSA representing after-tax contributions (such as COBRA continuation premiums)."
Q: The HEART Act specifies when the distribution can be made – it can start as early as the date the reservist is called to duty and up to the ‘last day the reimbursements could otherwise be made for the plan year.” Is this referring to the end of the plan year, or the end of the run-out period of the plan year?
A: The IRS guidance clearly states “before the last day of the plan year,” although the guidance does include any grace period the plan may have. The request has to be made before the last day of the plan year, and the employer then has up to 60 days to issue the distribution to the employee. The IRS guidance states "An employee must request a QRD on or after the date of the order or call to active duty, and before the last day of the plan year (or grace period, if applicable) during which the order or call to active duty occurred. An employer must pay the QRD to the employee within a reasonable time, but not more than 60 days after the request for a QRD has been made. A QRD may not be made with respect to a plan year ending before the order or call to active duty. In addition, a QRD may only be made on or after the effective date of amendment of the plan to provide for QRDs.“
Other points I would highlight about the guidance are the timing of the payment by the employer (see bullet point immediately above), the guidance on the cafeteria plan putting administrative procedures in place, and the guidance on substantiation of the leave and extending the right to the distribution to a person whose initial leave period is extended; for the latter two points, the guidance provides as follows (underlining added):
Q: What substantiation can an employer require from the employee?
A: After an employee requests a QRD and before the employer may distribute an amount, the employer must first receive a copy of the order or call to active duty. An employer may rely on the order or call to determine the period that the employee has been ordered or called to active duty. If the order or call specifies that the period of active duty is for 180 days or more or is indefinite, the employee is eligible for a QRD. The employee’s eligibility is not affected if the actual period of active duty is less than 180 days or is otherwise changed.
If the period specified in the order or call is less than 180 days, a QRD is not allowed. However, subsequent calls or orders that increase the total period of active duty to 180 days or more will qualify an employee for a QRD. Thus, for example, if an employee is ordered or called to active duty for 120 days, and his or her order or call is subsequently extended for an additional 60 days, that individual qualifies for a QRD.
Q: What is the transition period referred to in the HEART Act?
A: The IRS provides a transition rule for QRDs made before January 1, 2010. Under this transition rule, a cafeteria plan may be amended retroactively to permit QRDs requested on or before December 31, 2009, provided all of the other requirements are met. However, this transition rule does not allow an employee to request a QRD with respect to a plan year after the plan year (or the grace period, if applicable) during which the order or call to active duty occurred.
What Should an Employer Do?
- Review this bulletin and define any determining factors (i.e., employee demographics) and decide on whether you will implement this optional provision in your plan
- If a determination to implement this provision is made, discuss with your FSA administrator their ability to administer this provision and any special reporting requirements you may have
- We recommend amending your cafeteria plan document prospectively to allow adequate time to communicate the changes to your employees and to address administrative requirements before the implementation of this provision
- If you are interested in adopting the HEART Act as part of your Health FSA plan, please contact us at FSA@proviewbenefits.com
