Here is a question I need help with:

I have a 125 client who has had a very poor year in regard to employees signing up as participants, making claims and collecting their annual declared amount, and then terminating early in the plan year before all the payroll deductions can be made.

If at year-end (and after the grace period) a client's Flexible Spending Account balance is in the negative whose liability is the deficit? I presume that it is the Employer's responsibility to make up this deficit amount to the Plan Administrator.

Am I Correct?

Thanks for your help in this.

The proposed regs under 1.125-2, Q&A-7 would seem to indicate that the employer is responsible.

"...health FSAs must exhibit the risk-shifting and risk-distribution characteristics of insurance..."

"...A health FSA will not qualify for tax-favored treatment under sections 105 and 106 of the Code if the effect of the reimbursement arrangement eliminates all, or substantially all, risk of loss to the employer maintaining the plan..."

I agree that the burden lays with the Employer.

However this situation raises a question: Under what circumstances did these employees terminate their participation? Have they terminated their employment? Did they have any other "qualifying" events? We had a similar experience several years ago where the on-site contact person did not realize that the participants had to satisfy the qualifying events as determined in the Plan Document...and as it turned out, she was letting people term with the excuse of "they couldn't afford to have it taken out of their paycheck" !

But yes, the employer accepts this risk as part of Section 125.
(But remind them, that the Use-It-Or-Lose-It rule also applies and as such could benefit from fund forfeitures in future years)

The problem is that you can't take the deficit amount of an employee's last paycheck- no matter what. That is against the IRS regulations. It is part of the risk that an employer takes on by offering a Cafeteria Plan- and the employer gets the tax benefits (and forfeitures) if the employees do not terminate or use up their account balance at the end of the year.

~Rachel