IRS Expands Cafeteria Plan Change-in-Status Rules in Connection with Family Glitch Fix

(Parker Tax Publishing November 2022)

The IRS expanded the application of the permitted change-in-status rules for health coverage under Code Sec. 125 cafeteria plans in order to allow participants to revoke an election for family coverage under a group health plan to allow a family member to enroll in a qualified health plan through a health insurance exchange. The guidance was issued in conjunction with the final regulations issued in T.D. 9968, which provide that the affordability of an offer of group health plan coverage for a related individual is based on the employee's cost to cover the employee and the employee's related individuals. Notice 2022-41.

Background

Under Code Sec. 125(d)(1), a cafeteria plan means a written plan maintained by an employer under which all participants are employees and under which all participants may choose among two or more benefits consisting of cash and qualified benefits. Qualified benefits include employer-provided accident and health plans excludable from gross income. Generally, a written cafeteria plan generally must provide that elections are irrevocable, except to the extent that the optional change-in-status rules in Reg. Sec. 1.125-4 have been included in the cafeteria plan. Reg. Sec. 1.125-4 provides rules on the circumstances in which a cafeteria plan may permit changes to elections under the plan.

The Affordable Care Act (ACA) created the ability to enroll in qualified health plans (QHPs) through a Health Insurance Exchange (Exchange). Special enrollment rights under Code Sec. 9801(f) concern rights to enroll in a group health plan due to loss of other coverage or certain family events, but do not include the ability to enroll in a QHP through an Exchange. The ACA includes separate provisions regarding enrollment in QHPs through an Exchange during open and special enrollment periods.

In order to allow employees to enroll in a QHP through an Exchange if they would prefer that coverage, Notice 2014-55 expanded the ability of cafeteria plans to allow employees to revoke elections for group health plan coverage in two situations: (1) where an employee has a specified reduction in hours; and (2) where an employee is eligible to enroll in a QHP through an Exchange. However, Notice 2014-55 does not allow the revocation of an election for group health plan coverage when only related individuals, and not the employee, become eligible to enroll in a QHP through an Exchange.

Code Sec. 36B allows a premium tax credit (PTC) to applicable taxpayers who satisfy certain eligibility requirements, including that an individual in the taxpayer's family enrolls in a QHP through an Exchange for one or more months in which the individual is not eligible for employer-sponsored minimum essential coverage (including group health plan coverage) or certain other minimum essential coverage. Code Sec. 36B(c)(2)(C) generally provides that an individual is not treated as eligible for group health plan coverage if the coverage offered is unaffordable or does not provide minimum value. However, an individual who enrolls in group health plan coverage is eligible for that coverage, and therefore ineligible for a PTC, irrespective of whether it is affordable or provides minimum value.

Under final regulations issued in 2013, the affordability of group health plan coverage for an individual who may enroll in the coverage because of a relationship to an employee of the employer (a related individual) was based on the employee's self-only cost to enroll in the coverage. This rule has been referred to as the "family glitch." Recently, final regulations were issued in T.D. 9968 to fix the family glitch. The final regulations provide that the affordability of group health plan coverage for a related individual is based on the employee's cost to cover the employee and the employee's related individuals.

Under the current change-in-status rules under Reg. Sec. 1.125-4 and Notice 2014-55, a cafeteria plan is not permitted to allow an employee to revoke an election of family coverage under a group health plan during a period of coverage and elect self-only coverage (or family coverage including one or more already-covered related individuals) solely to allow one or more related individuals who had also been enrolled in the group health plan to instead enroll in a QHP through an Exchange (or separate QHPs if there is more than one related individual). This is the case even when the related individuals are newly eligible to enroll in a QHP through an Exchange during a special enrollment period or during the Exchange's annual open enrollment period.

As noted previously, under Reg. Sec. 1.36B-2(c)(3)(v)(A)(2), affordability of an offer of group health plan coverage for a related individual is based on the employee's cost to cover the employee and the employee's related individuals. Consequently, an employee may wish to revoke the election of group health plan coverage for one or more related individuals so the related individuals may enroll in a QHP through an Exchange and be allowed a PTC for the related individual's QHP coverage. In the case of group health plan coverage elected through a non-calendar year cafeteria plan, however, or in situations in which a PTC would be allowed for a related individual during the plan year if the related individual was enrolled in a QHP through an Exchange and not in the group health plan coverage, current rules require the employee to delay this change until the plan's annual open enrollment period, even if the employee would prefer to make the change sooner.

Notice 2022-41

In Notice 2022-41, the IRS expanded the application of the permitted change-in-status rules for health coverage under a cafeteria plan to allow a cafeteria plan participant to revoke an election for family coverage under a group health plan in order to allow one or more family members to enroll in a QHP through an Exchange. The employee will be able to elect out of family coverage and into self-only coverage (or family coverage including one or more already-covered related individuals) under that health plan prospectively during a period of coverage, provided specific conditions are satisfied.

Observation: The IRS stated that it intends to modify the regulations under Code Sec. 125 consistent with the provisions of Notice 2022-41. According to the IRS, taxpayers may rely on the guidance in Notice 2022-41 for plan amendments allowing elections effective on or after January 1, 2023.

Under Notice 2022-41, in addition to the situations described in Notice 2014-55, a non-calendar year cafeteria plan may allow an employee to revoke prospectively an election of family coverage under a group health plan (that is not a health flexible spending account) and that provides minimum essential coverage (as defined in Code Sec. 5000A(f)(1)), provided the following conditions are satisfied:

(1) one or more related individuals are eligible for a special enrollment period to enroll in a QHP through an Exchange, or one or more already-covered related individuals seeks to enroll in a QHP during the Exchange's annual open enrollment period; and

(2) the revocation of the election of coverage under the group health plan corresponds to the intended enrollment of the related individual or related individuals in a QHP through an Exchange for new coverage that is effective beginning no later than the day immediately following the last day of the original coverage that is revoked.

If the employee does not enroll in a QHP through an Exchange as set forth in Notice 2014-55, the employee must elect self-only coverage (or family coverage including one or more already-covered related individuals) under the group health plan. A cafeteria plan may rely on the reasonable representation of an employee that the employee and/or related individuals have enrolled or intend to enroll in a QHP through an Exchange for new coverage that is effective beginning no later than the day immediately following the last day of the original coverage that is revoked.

To allow the new permitted election changes under Notice 2022-41, an employer must amend a cafeteria plan to provide for these election changes. An employer must adopt the amendment on or before the last day of the plan year in which the elections are allowed, and the amendment may be effective retroactively to the first day of that plan year, provided that the cafeteria plan operates in accordance with the guidance under Notice 2022-41 and the employer informs participants of the amendment, and provided further that an employer may amend a cafeteria plan to adopt the new permitted election changes for a plan year that begins in 2023 at any time on or before the last day of the plan year that begins in 2024. However, in no event may an employer amend a cafeteria plan to allow an election to revoke coverage on a retroactive basis.

For a discussion of making elections under a cafeteria plan, see Parker Tax ¶122,535.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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