We have a Section 125 plan for FSAs and premium reduction for the health plan. If an employee experiences a status change, such as divorce or child reaches maximum age, but doesn't notify us until after the 31 day window, can the spouse or child be dropped when we are notified? Under our self-insured health plan, the former spouse and over-aged child are no longer eligible dependents for coverage and claims won't be paid. If they are dropped from our health coverage, can the employee contribution changed be changed (or is that their punishment for late notification) What type of documentation should we keep in the event of an audit by the IRS of our Section 125 plan?

Does your plan document specify that the employee must notify you within 31 days? The IRS, even with the new regs which went into effect March 23, did not put a date requirement on notification. IF your document does not require a date, you should be able to make those changes as long as (1) the time period is reasonable and (2) you are internally consistent.