Question: In this bonus season, an employee has requested additional dependent care FSA and commuter benefits deductions from his bonus. Is that permitted?
Compliance Team Response:
Section 125 Dependent Care FSA: No Contributions from Bonus
Our recommendation is that the company not take additional dependent care FSA contributions from an employee’s bonus check.
The Section 125 cafeteria plan regulations that govern employee pre-tax contributions for FSA and H&W premiums require that the interval for employee salary reductions be uniform for all participants. This means that you cannot have one employee paying contributions at a different interval than another (e.g., one pays each paycheck while one pays each month).
Including an additional contribution for a bonus check (that does not apply uniformly to all employees) likely violates that requirement. Although it’s not explicit in the regulations that salary contributions be taken ratably, it would defeat the purpose of the uniform interval requirement to provide that employees may be paying different amounts at the set uniform interval. Therefore, most view doubling-up on contributions as not permitted under Section 125.
For example, assume an employee elects to contribute $5,000 to the dependent care FSA, and the company has 24 pay periods. The contribution per semi-monthly pay period is $208.33. It cannot be $300 one pay period, $200 the next, etc. The contributions must be taken ratably throughout the year.
Our recommendation is therefore that the company should not permit employees to make an additional dependent care FSA contribution from a bonus check. The company should instead be limited to taking the standard per-paycheck FSA contribution—even when bonus amounts (or other contingent compensation) are paid.
Section 132 Commuter Benefits: Increase Election at Any Time
With respect to the commuter benefits, employees can change their election monthly for any reason. Unlike the §125 cafeteria plan rules for the FSA, the §132 rules do not require that commuter elections be irrevocable for the plan year.
In other words, the commuter benefit election rules are similar to the 401(k) deferral election rules. These elections may be changed each month for any reason (i.e., employees are not locked into an OE election for the duration of the plan year unless they experience a permitted election change event). Employees can freely join, increase, decrease, or revoke commuter benefit elections each month for any reason.
So in this situation, employees receiving a bonus can simply increase their monthly election for commuter benefits if that is their desired outcome. That contribution will still generally come from regular salary (not the bonus), but it will have the same result.
Prop. Treas. Reg. §1.125-5(g)(2):
(2) Interval for employees’ salary reduction contributions. The cafeteria plan is permitted to specify any interval for employees’ salary reduction contributions. The interval specified in the plan must be uniform for all participants.
Prop. Treas. Reg. §1.125-1(c)(7)(ii)(F):
(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)(1):
(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.
Treas. Reg. §1.132-9, Q/A-14:
(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).
(iii) The arrangement would also satisfy the requirements of this Q/A-14 (and Q/A-13 of this section) if employees are allowed to make an election at any time before the first or the fifteenth day of the month to reduce their compensation payable on that payroll date by an amount not in excess of one-half of the applicable statutory monthly limit (depending on the type of qualified transportation fringe elected by the employee) and P provides a mass transit pass on or after the applicable payroll date for the compensation reduction amount elected by the employee for the payroll date or reimburses the cost of other qualified transportation fringes used by the employee on or after the payroll date up to the compensation reduction amount elected by the employee for that payroll date.
Disclaimer: The intent of this analysis is to provide the recipient with general information regarding the status of, and/or potential concerns related to, the recipient’s current employee benefits issues. This analysis does not necessarily fully address the recipient’s specific issue, and it should not be construed as, nor is it intended to provide, legal advice. Furthermore, this message does not establish an attorney-client relationship. Questions regarding specific issues should be addressed to the person(s) who provide legal advice to the recipient regarding employee benefits issues (e.g., the recipient’s general counsel or an attorney hired by the recipient who specializes in employee benefits law).