Employee Benefits-IRS Issues A Private Letter Ruling Discussing Unused Funds In A Flexible Benefit Plan

In a private letter ruling, dated October 11, 2016 and given number: 2016-0077, the Internal Revenue Service provided the following guidance for determining whether unused funds in a flexible benefit plan default to the U.S. Treasury, when a business ceases operations.

A flexible benefit plan (a type of “cafeteria plan”) is subject to requirements under section 125 of the Internal Revenue Code (the “Code”).  Section 125 does not require that unused funds revert to the U.S. Treasury when the employer ceases operations and the plan terminates.  In addition, how unused funds are disposed of when the plan terminates would depend on what the plan document provides about plan termination and the facts and circumstances at that time.  Proposed Treasury Regulations under section 125 of the Code, however, do set forth rules on the use of unused amounts forfeited by a plan participant with respect to an ongoing plan. Proposed Treasury Regulation § 1.125- 5(o)(1) provides that forfeitures may be:

  • Retained by the employer maintaining the plan,
  • Used to defray plan expenses,
  • Returned to employees (that is, current participants) and allocated on a reasonable and uniform basis, based on, for example, contributions and not on claims experience.

In this case, during the months a certain employee (the “Employee”) was employed, the employer deposited money into its flexible benefit plan (the “Flex Plan”) on the Employee’s behalf, and the Employee’s account under the Flex Plan was credited with these amounts.  According to the Flex Plan’s summary plan description, health care expenses incurred on or before termination of employment could be reimbursed.

The Employee had unused funds in his Flex Plan account when his employment terminated, but he did not have unreimbursed health care expenses as of that date. The Flex Plan document provided that any unused funds in an account reverted to the plan to pay plan administrative expenses.  The Employee was told that because his former employer went out of business, any such unused funds defaulted to the U.S. Treasury.

It appears that unused funds in an employee’s account under the Flex Plan are forfeited upon the employee’s termination of employment, unless the employee had reimbursable health care expenses on or before the termination and submitted a claim within 60 days.  This is consistent with Proposed Treasury Regulation §§ 1.125- 6(a)(2)(i) and (iii), which together provide that a plan is prohibited from reimbursing health care expenses incurred after an employee terminates employment and no longer participates in the plan.  As noted above, how unused funds in employees’ accounts are disposed of when the plan terminates would depend on what the plan document provides about plan termination and the facts and circumstances at that time.  As such, the funds do not necessarily default to the U.S. Treasury.