True story: “It’s my God-given right as an American citizen to make pre-tax deductions from my employee’s checks and you’re just trying to sell me something.” Yes, someone actually told me this to my face and I’ve heard it in the voices of many who were not so blunt. Sorry Mr. America, there are rules about not paying the government their pound of flesh and yes, even you have to follow the rules to make it legitimate. If you want to make an IRS-approved pre-tax deduction, you’re going to need a good old All-American Premium Only Plan (POP).
What are the hoops to jump through (I mean rules) to legitimize the practice of deducting insurance premiums and Health Savings Account (HSA) contributions on a pre-tax basis? (Yes, I said HSA…if an employee contributes to an HSA account pre-tax, you need a POP.)
Here are the requirements set by the IRS under Section 125 of the Code to allow an employer to make pre-tax deductions from an employee paycheck – and they all need to be followed:
- A Plan Document. This document describes how an employee can elect to participate in the POP. The employer needs to formally adopt the POP prior to the first day of the plan year.
- A Summary Plan Description. A copy must be distributed to every employee who is going to participate in the POP and have a pre-tax deduction.
- An Election Form. While not mandatory, it’s recommended. Obtaining an employee’s affirmative written (or electronic media) agreement on a timely basis clearly constitutes an acceptable election. The Plan Document will identify the type of election category adopted by the POP. The four types of elections are:
- Affirmative. Affirmative elections are the cleanest way from a legal standpoint and the method SBA uses with all our POP documents.
- Negative
- Evergreen
- Rolling
- Change of Status Form. These forms must be completed every time a participant changes their election from $xxx.xx to something greater or smaller and it must be for a qualifying reason. Financial hardship is not a legal reason to drop coverage in the middle of the plan year.
- Non-Discrimination Testing. Testing needs to be conducted on the POP to ensure the POP does not discriminate in favor of highly compensated individuals by allowing greater eligibility or key employees having greater than 25% participation in the POP.
If all the rules above are followed, then Mr. America has the right to deduct from the employee’s checks on a pre-tax basis for the first year. For the second year, non-discrimination testing and distribution of election forms (if affirmative elections) are required to be done all over again. If all the above-mentioned rules are not followed, then Mr. America will fail an Internal Revenue Service or Department of Labor audit and no amount of lamenting or flag-waving will change the outcome.
Are your clients in compliance with the POP rules? Have more questions? Contact us.