IRS Provides Details for Qualified Reservist Distribution from Health Flexible Spending Accounts

As we previously reported in our July 28, 2008 Benefits Alert, the Heroes Earnings Assistance and Relief Tax Act of 2008 created a new cafeteria plan distribution option for "qualified reservists." Under this option, cafeteria plans may allow participants who are called to active duty in the U.S. military for at least 180 days to receive a distribution of the unused balance from their health flexible spending accounts (FSA). The HEART Act left many unanswered questions regarding the mechanics of these "qualified reservist distributions" (QRDs). Recent IRS guidance in Notice 2008-82 provided clarity on several of these outstanding issues.

Timing

Generally, cafeteria plans must be amended before allowing any QRD. However, the new IRS guidance establishes a transition rule: employers can amend their cafeteria plan any time before January 1, 2010 with a retroactive effective date back to the first QRD (but no earlier than June 18, 2008 when the HEART Act first established QRDs). A reservist can request a QRD beginning on the day the reservist is called to duty. The IRS clarified that the end of the period during which a reservist can request a QRD is the end of the plan year during which the call to duty occurred, including a plan's grace period, if applicable. Finally, the distribution must be made within a reasonable time of the request, but no more than 60 days after the request.

Amount

The IRS also clarified how to determine the amount of a QRD. In general, cafeteria plans that allow QRDs should specify how the plan will determine an employee's health FSA balance for purposes of making QRDs. Choices include calculating the difference between the amount elected by the participant and the amount reimbursed for medical expenses as of the date of the request, calculating the amount contributed to the health FSA as of the date of the request less health FSA reimbursements received as of the date of the request, or specifying some other amount (but no greater than the entire amount elected for the health FSA for the plan year, less reimbursements). If the plan does not specify how to determine the amount of a QRD, the default amount is the difference between the amount actually contributed into the health FSA and the amount reimbursed as of the date of request. The amount of a QRD may not include any balance of a dependent care FSA or the balance of a health FSA from a plan year that ended prior to the call to duty.

Procedure

Before granting an employee's request for a QRD, employers must receive a copy of the employee's order or call to duty. Employers can rely on the period of duty specified in the order, and an employee's eligibility is not affected if the actual period of active duty is less than 180 days. Employers can make a QRD if consecutive calls to duty total at least 180 days. Cafeteria plans must allow reservists to submit and be reimbursed for expenses incurred before the date a QRD is requested, but the plan may stop reimbursements after a QRD is requested.

Taxation

Qualified reservist distributions are considered wages subject to both income and employment taxes. The QRD should be reported on the employee's W-2 form for the year in which the QRD is paid to the employee.

Next Steps

Employers that have already allowed QRDs from their cafeteria plans should amend their plans to reflect their rules and procedures regarding QRDs no later than December 31, 2009. Some employers may have already amended their cafeteria plans to allow QRDs and, in that case, they should review the amendment to determine whether they need to make any changes based on the recent clarifications. QRDs made on or after January 1, 2010 will require a prospective plan amendment.