The Heroes Earnings Assistance and Relief Tax Act of 2008 (the “HEART Act”), as enacted in the summer of 2008, has created an opportunity for eligible reservists who are ordered or called to active duty to request distributions from the unused balances in their health Flexible Spending Accounts (“FSAs”). This development was discussed in a previous McGuireWoods LLP WorkCite. On September 29, 2008, the Internal Revenue Service released additional guidance on these distributions through Notice 2008-82. The Notice provides valuable information regarding the features and administration of these distributions for plan sponsors that choose to adopt them as an option in their cafeteria plans.
The distributions, called Qualified Reservist Distributions (“QRDs”), were added to the Internal Revenue Code (“Code”) through an amendment to Code section 125 and provide a valuable exception to the normal FSA “use-it-or-lose-it” rule. Generally, the FSA rules restrict distributions solely to reimbursement for medical expenses. However, a QRD permits reservists who are ordered or called to active duty for a specific time period to withdraw FSA amounts without incurring a medical expense, thereby avoiding potential forfeitures under the use-it-or-lose-it rule.
To be eligible for a QRD, the individual requesting the distribution must be a member of a reserve component ordered or called to active duty for a period of 180 days or more (or for an indefinite time period), and must make the distribution request during the period beginning on the day he or she is called to active duty and ending on the last day of the plan year (including the grace period, if applicable) that includes the date of the order or call to active duty.
Although the initial effective date of the QRD option is coincident with the effective date of the HEART Act (June 18, 2008), a QRD may be available for those reservists who were ordered or called to active duty before June 18, 2008, if:
- The individual’s period of active duty continues after June 18, 2008;
- The individual’s period of active duty meets the duration requirements; and
- The plan in which the reservist participates provides for the QRD option.
QRDs are not available where:
- The order or call to active duty is for any individual other than the employee, including the spouse of the employee;
- The QRD request is made during a plan year after the last day of the plan year during which the order or call to active duty occurred; and
- The period specified in the order or call to active duty is less than 180 days.
Where a reservist’s initial order or call to active duty does not exceed 180 days, but is later extended beyond the 180 day threshold, the reservist may qualify for a QRD.
The Notice does not state whether an individual must be an active employee when ordered or called to duty. Consequently, it is silent regarding whether a terminated employee with an FSA account balance may request a QRD after he or she is ordered or called to active duty and the other distribution requirements are met.
Amount of QRDs
Prior to authorizing a QRD plan distribution, the plan administrator must receive a copy of the order or call to active duty from the reservist who requests the distribution. A plan may rely on the order or call to determine whether the specified duration meets the requirements. Furthermore, where the initial order or call meets the time requirements, but the actual period of active duty is changed to less than the required period, the employee’s QRD eligibility (including any receipt of a QRD) is not affected.
The plan document may use one of several methods to calculate the amount available as a QRD. The amount available for distribution may be:
- The entire amount elected for the health FSA for the plan year, minus any 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 any health FSA reimbursements received as of the date of the QRD request; or
- Some other amount, but not exceeding the entire amount elected for the health FSA for the plan year, minus reimbursements.
If the plan document does not specifically indicate the method for calculating the available QRD amount, the deemed default rule is the second option above.
Amounts that are not eligible to be received in a QRD include amounts:
- Forfeited under the plan’s “use-it-or-lose-it” rule on or before June 18, 2008;
- Attributable to a prior plan year; or
- That have been contributed to non-health FSAs.
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. Since health FSAs are “plans” that are subject to the claims procedures outlined in the Employee Retirement Income Security Act, a QRD request should be treated as any other claim for benefits under the FSA’s procedures.
Timing of QRD Requests
The plan must permit employees to submit health FSA claims for medical expenses that were incurred before the date a QRD is requested and must pay or reimburse those claims. However, with regard to medical expenses that are incurred after the QRD is requested, the plan may either terminate the employee’s right to submit additional claims or permit the claims incurred prior to the end of the plan year (including any applicable grace period) in the same manner as any other medical claims submitted to the plan.
Tax Effects of QRDs
A QRD is included in the gross income and wages of the employee who receives the distribution. That amount must be reported on the employee’s Form W-2 and is also subject to employment tax. The amount reported as wages is reduced by any amount contributed to the health FSA that is attributable to after-tax contributions, such as COBRA continuation premiums.
QRDs are not required additions to FSAs. However, where a plan sponsor decides to offer QRDs, the cafeteria plan must be amended, and the amendment must apply uniformly to all eligible plan participants.
Distributions generally should not be made prior to a plan amendment authorizing QRDs. However, Notice 2008-82 offers a transition rule for plan sponsors that wish to adopt QRDs following the HEART Act’s enactment on July 18, 2008, but that have not had the opportunity to adopt a plan amendment. The transition rule allows a plan to be retroactively amended by December 31, 2009. The effective date of such a retroactive amendment should match the date of the first QRD paid out of the plan, but cannot be earlier than June 18, 2008. It is also important to note that the transition rule for retroactive QRDs does not extend the period during which an employee may request a QRD.
Regardless of when a plan is amended, the transition rule does not allow an employee to request a QRD with respect to a plan year after the last day of the plan year (including any applicable grace period) during which the order or call to active duty occurs.
The transition rules dovetail with the need of all employers to review the terms of their cafeteria plans and to bring those plans into compliance with new regulations issued in proposed form in 2007 by the United States Department of the Treasury. Those regulations were expected to be effective January 1, 2009, following the issuance of final regulations. However, due to a delay within the Department, the final regulations have not yet been issued, and their effective date will likely be extended to January 1, 2010.
Plan sponsors requiring additional assistance with Qualified Reservists Distributions, including amending cafeteria plans to provide for QRDs, should contact any member of the McGuireWoods Employee Benefits or Labor & Employment teams.