Author: Andrew Wilson, Regulatory and Legislative Specialist, Hays Companies

How COBRA Applies to Health FSAs

The Consolidated Omnibus Budget Reconciliation Act of 1985 (COBRA) contains a series of laws which states that any qualified beneficiary enrolled in a group health plan who loses group health plan coverage due to a qualifying event, may elect to continue group health plan coverage for a limited time on a self-pay basis.

Health Flexible Spending Accounts (HFSAs) are a type of tax-advantaged medical account that reimburses employees for eligible health care expenses and is a component of many employer-sponsored cafeteria plans.

As with a major medical plan, an employer subject to COBRA must offer COBRA coverage to qualified beneficiaries who lose their HFSA coverage as the result of a qualifying event, unless an exception applies (for example, the small employer exception for plans maintained by employers with fewer than 20 employees on typical business days during the preceding calendar year).

HFSAs, however, are not ordinary group health plans for purposes of COBRA. Given their special nature and the rules that govern them, those HFSAs that must offer COBRA coverage face some unique issues.

Health FSAs and “the special limited COBRA obligation.”

For qualifying HFSAs, COBRA coverage must be offered to qualified beneficiaries who have underspent their accounts. The coverage, however, may be terminated at the end of the plan year in which the qualifying event occurred, and it confers no re-enrollment rights during a plan’s open enrollment period. Despite this, any grace period that applies to HFSA participants will also apply to those who are receiving COBRA coverage under the HFSA at the end of a plan year.

When is a qualified beneficiary eligible for an offer of COBRA?

If the available benefit for the remainder of the plan year (after taking into consideration previous salary reductions less claims submitted for reimbursement prior to the date of the qualifying event) exceeds the COBRA premium at the time of a qualifying event, the plan sponsor is obligated to offer COBRA. Carryover amounts (in the case of health FSAs that provide a carryover) are included to determine the available benefit.

Qualifying health care expenses incurred by employees, their spouses and dependents are eligible for non-taxable reimbursement under the health FSA. All such individuals are considered qualified beneficiaries who have independent election rights.

A qualifying event occurs in connection with a change in employment status (i.e., reduction in hours or termination of employment), as well as when a dependent loses eligible status (such as in the event of a divorce or a child ceasing to be an eligible dependent).

Only health FSAs that meet three conditions qualify for the special limited COBRA obligation.

Per IRS regulations, HFSAs will qualify for the special limited COBRA obligation only if the HFSA provides excepted benefits and the COBRA premium under the HFSA meet certain minimums.

Benefits provided under an HFSA “are excepted for a class of participants” if the HFSA satisfies three conditions: (1) The Maximum Benefit Condition, (2) the Availability Condition, and (3) the COBRA Premium Condition. Each is discussed below.

Under the Maximum Benefit Condition, the maximum benefit payable under the HFSA to any participant in the class for a year cannot exceed two times the participant’s salary reduction election under the HFSA for the year (or, if greater, the amount of the employee’s salary reduction election for the HFSA for the year, plus $500).

“Maximum benefit” refers to the entire available HFSA benefit that the participant has elected to receive for a year, including employee elective contributions and amounts the employer contributes to the HFSA. HFSA carryovers are not considered when determining whether the HFSA meets the maximum benefit condition and, similarly, IRS officials have informally indicated that benefits provided during a prior year’s grace period are attributed to the prior year.

The Availability Condition—Other group health plan coverage (apart from excepted benefits) must be made available for the year to the class of participants by reason of their employment. As its name suggests, the test is one of availability—it does not matter whether anyone in the class of HFSA participants elects the other coverage. However, where an employer’s HFSA eligibility provisions are more expansive than those requirements that determine eligibility for the medical plan (i.e., more employees are eligible for the FSA than the medical plan), then this condition might not be met.

The COBRA Premium Condition—The maximum annual COBRA premium chargeable for HFSA COBRA coverage must equal or exceed the maximum annual HFSA coverage amount. To satisfy this condition, the HFSA must offer no insurance protection, which is typically the case with an HFSA under a cafeteria plan (most health FSAs offered under a cafeteria plan provide only a tax benefit when viewed with hindsight from the perspective of a participant who remains in the HFSA for an entire plan year). Frankly, most HFSAs under a cafeteria plan will satisfy the COBRA premium condition, because COBRA “premiums” for a HFSA are generally the remainder of the employee’s annual election for the plan year, plus a permitted 2% COBRA administration fee.

An employer can design a plan so that its HFSA qualifies for the special limited COBRA obligation by satisfying the three conditions above.

Does the special limited COBRA obligation apply on a class or plan basis?

The relevant regulations use the phrase “class of participants,” but without further guidance from the IRS as to whom or what constitutes a class of participants, it makes sense to treat the special limited COBRA obligation as applicable to HFSAs only if all three conditions discussed above are satisfied with respect to all participants in the HFSA (meaning, for the plan as a whole).

Although “class of participants” arguably only refers to those participants within an HFSA, rather than the plan as a whole, there are bodies of authority that support the opposite interpretation. For example, the language of the HFSA provisions in the IRS COBRA regulations lends support to a plan-by-plan approach for determining when the special limited obligation applies. Further guidance from the IRS on this language will be needed in the future.

This document is provided for general information purposes only and should not be considered legal or tax advice or legal or tax opinion on any specific facts or circumstances. Readers are urged to consult their legal counsel and tax advisor concerning any legal or tax questions that may arise.

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