[Code of Federal Regulations]
[Title 26, Volume 2]
[Revised as of April 1, 2004]
From the U.S. Government Printing Office via GPO Access
[CITE: 26CFR1.125-4]

[Page 528-537]
 
                       TITLE 26--INTERNAL REVENUE
 
    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)
 
PART 1_INCOME TAXES--Table of Contents
 
Sec. 1.125-4  Permitted election changes.

    (a) Election changes. A cafeteria plan may permit an employee to 
revoke an election during a period of coverage and to make a new 
election only as provided in paragraphs (b) through (g) of this section. 
Section 125 does not require a cafeteria plan to permit any of these 
changes. See paragraph (h) of this section for special provisions 
relating to qualified cash or deferred arrangements, and paragraph (i) 
of this section for special definitions used in this section.
    (b) Special enrollment rights--(1) In general. A cafeteria plan may 
permit an employee to revoke an election for coverage under a group 
health plan during a period of coverage and make a new election that 
corresponds with the special enrollment rights provided in section 
9801(f).
    (2) Examples. The following examples illustrate the application of 
this paragraph (b):

    Example 1. (i) Employer M provides health coverage for its employees 
pursuant to a plan that is subject to section 9801(f). Under the plan, 
employees may elect either employee-only coverage or family coverage. M 
also maintains a calendar year cafeteria plan under which qualified 
benefits, including health coverage, are funded through salary 
reduction. M's employee, A, is married to B and they have a child, C. In 
accordance with M's cafeteria plan, Employee A elects employee-only 
health coverage before the beginning of the calendar year. During the 
year, A and B adopt a child, D. Within 30 days thereafter, A wants to 
revoke A's election for employee-only health coverage and obtain family 
health coverage for A's spouse, C, and D as of the date of D's adoption. 
Employee A satisfies the conditions for special enrollment of an 
employee with a new dependent under section 9801(f)(2), so that A may 
enroll in family coverage under M's accident or health plan in order to 
provide coverage effective as of the date of D's adoption.
    (ii) M's cafeteria plan may permit A to change A's salary reduction 
election to family coverage for salary not yet currently available. The 
increased salary reduction is permitted to reflect the cost of family 
coverage from the date of adoption. (A's adoption of D is also a change 
in status, and the election of family coverage is consistent with that 
change in status. Thus, under paragraph (c) of this section, M's 
cafeteria plan could permit A to elect family coverage prospectively in 
order to cover B, C, and D for the remaining portion of the period of 
coverage.)
    Example 2. (i) The employer plans and permissible coverage are the 
same as in Example 1. Before the beginning of the calendar year, 
Employee E elects employee-only health coverage under M's cafeteria 
plan. Employee E marries F during the plan year. F's employer, N, offers 
health coverage to N's employees, and, prior to the marriage, F had 
elected employee-only coverage. Employee E wants to revoke the election 
for employee-only coverage under M's cafeteria plan, and is considering 
electing family health coverage under M's plan or obtaining family 
health coverage under N's plan.
    (ii) M's cafeteria plan may permit E to change E's salary reduction 
election to reflect the change to family coverage under M's accident or 
health plan because the marriage would result in special enrollment 
rights under section 9801(f), pursuant to which an election of family 
coverage under M's accident or health plan would be required to be 
effective no later than the first day of the first calendar month 
beginning after the completed request for enrollment is received by the 
plan. Since no retroactive coverage is required in the event of marriage 
under section 9801(f), E's salary reduction election may only be changed 
on a prospective basis. (E's marriage to F is also a change in status 
under paragraph (c) of this section, as illustrated in Example 1 of 
paragraph (c)(4) of this section.)

    (c) Changes in status--(1) Change in status rule. A cafeteria plan 
may permit

[[Page 529]]

an employee to revoke an election during a period of coverage with 
respect to a qualified benefits plan (defined in paragraph (i)(8) of 
this section) to which this paragraph (c) applies and make a new 
election for the remaining portion of the period (referred to in this 
section as an election change) if, under the facts and circumstances--
    (i) A change in status described in paragraph (c)(2) of this section 
occurs; and
    (ii) The election change satisfies the consistency rule of paragraph 
(c)(3) of this section.
    (2) Change in status events. The following events are changes in 
status for purposes of this paragraph (c):
    (i) Legal marital status. Events that change an employee's legal 
marital status, including the following: marriage; death of spouse; 
divorce; legal separation; and annulment.
    (ii) Number of dependents. Events that change an employee's number 
of dependents, including the following: birth; death; adoption; and 
placement for adoption.
    (iii) Employment status. Any of the following events that change the 
employment status of the employee, the employee's spouse, or the 
employee's dependent: a termination or commencement of employment; a 
strike or lockout; a commencement of or return from an unpaid leave of 
absence; and a change in worksite. In addition, if the eligibility 
conditions of the cafeteria plan or other employee benefit plan of the 
employer of the employee, spouse, or dependent depend on the employment 
status of that individual and there is a change in that individual's 
employment status with the consequence that the individual becomes (or 
ceases to be) eligible under the plan, then that change constitutes a 
change in employment under this paragraph (c) (e.g., if a plan only 
applies to salaried employees and an employee switches from salaried to 
hourly-paid with the consequence that the employee ceases to be eligible 
for the plan, then that change constitutes a change in employment status 
under this paragraph (c)(2)(iii)).
    (iv) Dependent satisfies or ceases to satisfy eligibility 
requirements. Events that cause an employee's dependent to satisfy or 
cease to satisfy eligibility requirements for coverage on account of 
attainment of age, student status, or any similar circumstance.
    (v) Residence. A change in the place of residence of the employee, 
spouse, or dependent.
    (vi) Adoption assistance. For purposes of adoption assistance 
provided through a cafeteria plan, the commencement or termination of an 
adoption proceeding.
    (3) Consistency rule--(i) Application to accident or health coverage 
and group-term life insurance. An election change satisfies the 
requirements of this paragraph (c)(3) with respect to accident or health 
coverage or group-term life insurance only if the election change is on 
account of and corresponds with a change in status that affects 
eligibility for coverage under an employer's plan. A change in status 
that affects eligibility under an employer's plan includes a change in 
status that results in an increase or decrease in the number of an 
employee's family members or dependents who may benefit from coverage 
under the plan.
    (ii) Application to other qualified benefits. An election change 
satisfies the requirements of this paragraph (c)(3) with respect to 
other qualified benefits if the election change is on account of and 
corresponds with a change in status that affects eligibility for 
coverage under an employer's plan. An election change also satisfies the 
requirements of this paragraph (c)(3) if the election change is on 
account of and corresponds with a change in status that effects expenses 
described in section 129 (including employment-related expenses as 
defined in section 21(b)(2)) with respect to dependent care assistance, 
or expenses described in section 137 (including qualified adoption 
expenses as defined in section 137(d)) with respect to adoption 
assistance.
    (iii) Application of consistency rule. If the change in status is 
the employee's divorce, annulment or legal separation from a spouse, the 
death of a spouse or dependent, or a dependent ceasing to satisfy the 
eligibility requirements for coverage, an employee's election under the 
cafeteria plan to cancel accident or health insurance coverage for any 
individual other than the spouse involved

[[Page 530]]

in the divorce, annulment or legal separation, the deceased spouse or 
dependent, or the dependent that ceased to satisfy the eligibility 
requirements for coverage, respectively, fails to correspond with that 
change in status. Thus, if a dependent dies or ceases to satisfy the 
eligibility requirements for coverage, the employee's election to cancel 
accident or health coverage for any other dependent, for the employee, 
or for the employee's spouse fails to correspond with that change in 
status. In addition, if an employee, spouse, or dependent gains 
eligibility for coverage under a family member plan (as defined in 
paragraph (i)(5) of this section) as a result of a change in marital 
status under paragraph (c)(2)(i) of this section or a change in 
employment status under paragraph (c)(2)(iii) of this section, an 
employee's election under the cafeteria plan to cease or decrease 
coverage for that individual under the cafeteria plan corresponds with 
that change in status only if coverage for that individual becomes 
applicable or is increased under the family member plan. With respect to 
group-term life insurance and disability coverage (as defined in 
paragraph (i)(4) of this section), an election under a cafeteria plan to 
increase coverage (or an election to decrease coverage) in response to a 
change in status described in paragraph (c)(2) of this section is deemed 
to correspond with that change in status as required by paragraph 
(c)(3)(i) of this section.
    (iv) Exception for COBRA. If the employee, spouse, or dependent 
becomes eligible for continuation coverage under the group health plan 
of the employee's employer as provided in section 4980B or any similar 
state law, a cafeteria plan may permit the employee to elect to increase 
payments under the employer's cafeteria plan in order to pay for the 
continuation coverage.
    (4) Examples. The following examples illustrate the application of 
this paragraph (c):

    Example 1. (i) Employer M provides health coverage (including a 
health FSA) for its employees through its cafeteria plan. Before the 
beginning of the calendar year, Employee A elects employee-only health 
coverage under M's cafeteria plan and elects salary reduction 
contributions to fund coverage under the health FSA. Employee A marries 
B during the year. Employee B's employer, N, offers health coverage to 
N's employees (but not including any health FSA), and, prior to the 
marriage, B had elected employee-only coverage. Employee A wants to 
revoke the election for employee-only coverage, and is considering 
electing family health coverage under M's plan or obtaining family 
health coverage under N's plan.
    (ii) Employee A's marriage to B is a change in status under 
paragraph (c)(2)(i) of this section, pursuant to which B has become 
eligible for coverage under M's health plan under paragraph (c)(3)(i) of 
this section. Two possible election changes by A correspond with the 
change in status: Employee A may elect family health coverage under M's 
plan to cover A and B; or A may cancel coverage under M's plan, if B 
elects family health coverage under N's plan to cover A and B. Thus, M's 
cafeteria plan may permit A to make either election change.
    (iii) Employee A may also increase salary reduction contributions to 
fund coverage for B under the health FSA.
    Example 2. (i) Employee C, a single parent, elects family health 
coverage under a calendar year cafeteria plan maintained by Employer O. 
Employee C and C's 21-year old child, D, are covered under O's health 
plan. During the year, D graduates from college. Under the terms of the 
health plan, dependents over the age of 19 must be full-time students to 
receive coverage. Employee C wants to revoke C's election for family 
health coverage and obtain employee-only coverage under O's cafeteria 
plan.
    (ii) D's loss of eligibility for coverage under the terms of the 
health plan is a change in status under paragraph (c)(2)(iv) of this 
section. A revocation of C's election for family coverage and new 
election for employee-only coverage corresponds with the change in 
status. Thus, O's cafeteria plan may permit C to elect employee-only 
coverage.
    Example 3. (i) Employee E is married to F and they have one child, 
G. Employee E is employed by Employer P, and P maintains a calendar year 
cafeteria plan that allows employees to elect no health coverage, 
employee-only coverage, employee-plus-one-dependent coverage, or family 
coverage. Under the plan, before the beginning of the calendar year, E 
elects family health coverage for E, F, and G. E and F divorce during 
the year and F loses eligibility for coverage under P's plan. G does not 
lose eligibility for health coverage under P's plan upon the divorce. E 
now wants to revoke E's election under the cafeteria plan and elect no 
coverage.
    (ii) The divorce is a change in status under paragraph (c)(2)(i). A 
change in the cafeteria plan election to cancel health coverage for F

[[Page 531]]

is consistent with that change in status. However, an election change to 
cancel E's or G's health coverage does not satisfy the consistency rule 
under paragraph (c)(3)(iii) of this section regarding cancellation of 
coverage for an employee's other dependents in the event of divorce. 
Therefore, the cafeteria plan may not permit E to elect no coverage. 
However, an election to change to employee-plus-one-dependent health 
coverage would correspond with the change in status, and thus the 
cafeteria plan may permit E to elect employee-plus-one-dependent health 
coverage.
    (iii) In addition, under paragraph (f)(4) of this section, if F 
makes an election change to cover G under F's employer's plan, then E 
may make a corresponding change to elect employee-only coverage under 
P's cafeteria plan.
    Example 4. (i) Employer R maintains a calendar year cafeteria plan 
under which full-time employees may elect coverage under one of three 
benefit package options provided under an accident or health plan: an 
indemnity option or either of two HMO options for employees who work in 
the respective service areas of the two HMOs. Employee A, who works in 
the service area of HMO 1, elects the HMO 1 option. 
During the year, A is transferred to another work location which is 
outside the HMO 1 service area and inside the HMO 2 
service area.
    (ii) The transfer is a change in status under paragraph (c)(2)(iii) 
of this section (relating to a change in worksite), and, under the 
consistency rule in paragraph (c)(3) of this section, the cafeteria plan 
may permit A to make an election change to elect the indemnity option or 
HMO 2 or to cancel accident or health coverage.
    (iii) The change in work location has no effect on A's eligibility 
under R's health FSA, so no change in A's health FSA is authorized under 
this paragraph (c).
    Example 5. (i) Employer S maintains a calendar year cafeteria plan 
that allows employees to elect coverage under an accident or health plan 
providing indemnity coverage and coverage under a health FSA. Prior to 
the beginning of the calendar year, Employee B elects employee-only 
indemnity coverage, and elects salary reduction contributions of $600 
during the year to fund coverage under the health FSA for up to $600 of 
reimbursements for the year. Employee B's spouse, C, has employee-only 
coverage under an accident or health plan maintained by C's employer. 
During the year, C terminates employment and loses coverage under that 
plan. B now wants to elect family coverage under S's accident or health 
plan and increase B's FSA election.
    (ii) C's termination of employment is a change in status under 
paragraph (c)(2)(iii) of this section, and the election change satisfies 
the consistency rule of paragraph (c)(3) of this section. Therefore, the 
cafeteria plan may permit B to elect family coverage under S's accident 
or health plan and to increase B's FSA coverage.
    Example 6. (i) Employer T provides group-term life insurance 
coverage as described under section 79. Under T's plan, an employee may 
elect life insurance coverage in an amount up to $50,000. T also 
maintains a calendar year cafeteria plan under which qualified benefits, 
including the group-term life insurance coverage, are funded through 
salary reduction. Employee D has a spouse and a child. Before the 
beginning of the year, D elects $10,000 of group-term life insurance 
coverage. During the year, D is divorced.
    (ii) The divorce is a change in status under paragraph (c)(2)(i) of 
this section. Under paragraph (c)(3)(iii) of this section, either an 
increase or a decrease in coverage is consistent with this change in 
status. Thus, T's cafeteria plan may permit D to increase or to decrease 
D's group-term life insurance coverage.
    Example 7. (i) Employee E is married to F and they have one child, 
G. Employee E's employer, U, maintains a cafeteria plan under which 
employees may elect no coverage, employee-only coverage, or family 
coverage under a group health plan maintained by U, and may make a 
separate vision coverage election under the plan. Before the beginning 
of the calendar year, E elects family health coverage and no vision 
coverage under U's cafeteria plan. Employee F's employer, V, maintains a 
cafeteria plan under which employees may elect no coverage, employee-
only coverage, or family coverage under a group health plan maintained 
by V, and may make a separate vision coverage election under the plan. 
Before the beginning of the calendar year, F elects no health coverage 
and employee-only vision coverage under V's plan. During the year, F 
terminates employment with V and loses vision coverage under V's plan. 
Employee E now wants to elect family vision coverage under U's group 
health plan.
    (ii) F's termination of employment is a change in status under 
paragraph (c)(2)(iii) of this section, and the election change satisfies 
the consistency rule of paragraph (c)(3) of this section. Therefore, U's 
cafeteria plan may permit E to elect family vision coverage (covering E 
and G as well as F) under U's group health plan.
    Example 8. (i) Before the beginning of the year, Employee H elects 
to participate in a cafeteria plan maintained by H's employer, W. 
However, in order to change the election during the year so as to cancel 
coverage, and by prior understanding with W, H terminates employment and 
resumes employment one week later.
    (ii) In this Example 8, under the facts and circumstances, a 
principal purpose of the termination of employment was to alter the

[[Page 532]]

election, and reinstatement of employment was understood at the time of 
termination. Accordingly, H does not have a change in status under 
paragraph (c)(2)(iii) of this section.
    (iii) However, H's termination of employment would constitute a 
change in status, permitting a cancellation of coverage during the 
period of unemployment, if H's original cafeteria plan election for the 
period of coverage was reinstated upon resumption of employment (for 
example, if W's cafeteria plan contains a provision requiring an 
employee who resumes employment within 30 days, without any other 
intervening event that would permit a change in election, to return to 
the election in effect prior to termination of employment).
    (iv) If, instead, H terminates employment and cancels coverage 
during a period of unemployment, and then returns to work more than 30 
days following termination of employment, the cafeteria plan may permit 
H the option of returning to the election in effect prior to termination 
of employment or making a new election under the plan. Alternatively, 
the cafeteria plan may prohibit H from returning to the plan during that 
plan year.
    Example 9. (i) Employee A has one child, B. Employee A's employer, 
X, maintains a calendar year cafeteria plan that allows employees to 
elect coverage under a dependent care FSA. Prior to the beginning of the 
calendar year, A elects salary reduction contributions of $4,000 during 
the year to fund coverage under the dependent care FSA for up to $4,000 
of reimbursements for the year. During the year, B reaches the age of 
13, and A wants to cancel coverage under the dependent care FSA.
    (ii) When B turns 13, B ceases to satisfy the definition of 
qualifying individual under section 21(b)(1) of the Internal Revenue 
Code. Accordingly, B's attainment of age 13 is a change in status under 
paragraph (c)(2)(iv) of this section that affects A's employment-related 
expenses as defined in section 21(b)(2). Therefore, A may make a 
corresponding change under X's cafeteria plan to cancel coverage under 
the dependent care FSA.
    Example 10. (i) Employer Y maintains a calendar year cafeteria plan 
under which full-time employees may elect coverage under either an 
indemnity option or an HMO. Employee C elects the employee-only 
indemnity option. During the year, C marries D. D has two children from 
a previous marriage, and has family group health coverage in a cafeteria 
plan sponsored by D's employer, Z. C wishes to change from employee-only 
indemnity coverage to HMO coverage for the family. D wishes to cease 
coverage in Z's group health plan and certifies to Z that D will have 
family coverage under C's plan (and Z has no reason to believe the 
certification is incorrect).
    (ii) The marriage is a change in status under paragraph (c)(2)(i) of 
this section. Under the consistency rule in paragraph (c)(3) of this 
section, Y's cafeteria plan may permit C to change his or her salary 
reduction contributions to reflect the change from employee-only 
indemnity to HMO family coverage, and Z may permit D to revoke coverage 
under Z's cafeteria plan.

    (d) Judgment, decree, or order--(1) Conforming election change. This 
paragraph (d) applies to a judgment, decree, or order (order) resulting 
from a divorce, legal separation, annulment, or change in legal custody 
(including a qualified medical child support order as defined in section 
609 of the Employee Retirement Income Security Act of 1974 (Public Law 
93-406 (88 Stat. 829))) that requires accident or health coverage for an 
employee's child or for a foster child who is a dependent of the 
employee. A cafeteria plan will not fail to satisfy section 125 if it--
    (i) Changes the employee's election to provide coverage for the 
child if the order requires coverage for the child under the employee's 
plan; or
    (ii) Permits the employee to make an election change to cancel 
coverage for the child if:
    (A) The order requires the spouse, former spouse, or other 
individual to provide coverage for the child; and
    (B) That coverage is, in fact, provided.
    (2) Example. The following example illustrates the application of 
this paragraph (d):

    Example. (i) Employer M maintains a calendar year cafeteria plan 
that allows employees to elect no health coverage, employee-only 
coverage, employee-plus-one-dependent coverage, or family coverage. M's 
employee, A, is married to B and they have one child, C. Before the 
beginning of the year, A elects employee-only health coverage. Employee 
A divorces B during the year and, pursuant to A's divorce agreement with 
B, M's health plan receives a qualified medical child support order (as 
defined in section 609 of the Employee Retirement Income Security Act of 
1974) during the plan year. The order requires M's health plan to cover 
C.
    (ii) Under this paragraph (d), M's cafeteria plan may change A's 
election from employee-only health coverage to employee-plus-one-
dependent coverage in order to cover C.


[[Page 533]]


    (e) Entitlement to Medicare or Medicaid. If an employee, spouse, or 
dependent who is enrolled in an accident or health plan of the employer 
becomes entitled to coverage (i.e., becomes enrolled) under Part A or 
Part B of Title XVIII of the Social Security Act (Medicare) (Public Law 
89-97 (79 Stat. 291)) or Title XIX of the Social Security Act (Medicaid) 
(Public Law 89-97 (79 Stat. 343)), other than coverage consisting solely 
of benefits under section 1928 of the Social Security Act (the program 
for distribution of pediatric vaccines), a cafeteria plan may permit the 
employee to make a prospective election change to cancel or reduce 
coverage of that employee, spouse, or dependent under the accident or 
health plan. In addition, if an employee, spouse, or dependent who has 
been entitled to such coverage under Medicare or Medicaid loses 
eligibility for such coverage, the cafeteria plan may permit the 
employee to make a prospective election to commence or increase coverage 
of that employee, spouse, or dependent under the accident or health 
plan.
    (f) Significant cost or coverage changes--(1) In general. Paragraphs 
(f)(2) through (5) of this section set forth rules for election changes 
as a result of changes in cost or coverage. This paragraph (f) does not 
apply to an election change with respect to a health FSA (or on account 
of a change in cost or coverage under a health FSA).
    (2) Cost changes--(i) Automatic changes. If the cost of a qualified 
benefits plan increases (or decreases) during a period of coverage and, 
under the terms of the plan, employees are required to make a 
corresponding change in their payments, the cafeteria plan may, on a 
reasonable and consistent basis, automatically make a prospective 
increase (or decrease) in affected employees' elective contributions for 
the plan.
    (ii) Significant cost changes. If the cost charged to an employee 
for a benefit package option (as defined in paragraph (i)(2) of this 
section) significantly increases or significantly decreases during a 
period of coverage, the cafeteria plan may permit the employee to make a 
corresponding change in election under the cafeteria plan. Changes that 
may be made include commencing participation in the cafeteria plan for 
the option with a decrease in cost, or, in the case of an increase in 
cost, revoking an election for that coverage and, in lieu thereof, 
either receiving on a prospective basis coverage under another benefit 
package option providing similar coverage or dropping coverage if no 
other benefit package option providing similar coverage is available. 
For example, if the cost of an indemnity option under an accident or 
health plan significantly increases during a period of coverage, 
employees who are covered by the indemnity option may make a 
corresponding prospective increase in their payments or may instead 
elect to revoke their election for the indemnity option and, in lieu 
thereof, elect coverage under another benefit package option including 
an HMO option (or drop coverage under the accident or health plan if no 
other benefit package option is offered).
    (iii) Application of cost changes. For purposes of paragraphs 
(f)(2)(i) and (ii) of this section, a cost increase or decrease refers 
to an increase or decrease in the amount of the elective contributions 
under the cafeteria plan, whether that increase or decrease results from 
an action taken by the employee (such as switching between full-time and 
part-time status) or from an action taken by an employer (such as 
reducing the amount of employer contributions for a class of employees).
    (iv) Application to dependent care. This paragraph (f)(2) applies in 
the case of a dependent care assistance plan only if the cost change is 
imposed by a dependent care provider who is not a relative of the 
employee. For this purpose, a relative is an individual who is related 
as described in section 152(a)(1) through (8), incorporating the rules 
of section 152(b)(1) and (2).
    (3) Coverage changes--(i) Significant curtailment without loss of 
coverage. If an employee (or an employee's spouse or dependent) has a 
significant curtailment of coverage under a plan during a period of 
coverage that is not a loss of coverage as described in paragraph 
(f)(3)(ii) of this section (for example, there is a significant increase 
in the deductible, the copay, or the out-of-

[[Page 534]]

pocket cost sharing limit under an accident or health plan), the 
cafeteria plan may permit any employee who had been participating in the 
plan and receiving that coverage to revoke his or her election for that 
coverage and, in lieu thereof, to elect to receive on a prospective 
basis coverage under another benefit package option providing similar 
coverage. Coverage under a plan is significantly curtailed only if there 
is an overall reduction in coverage provided under the plan so as to 
constitute reduced coverage generally. Thus, in most cases, the loss of 
one particular physician in a network does not constitute a significant 
curtailment.
    (ii) Significant curtailment with loss of coverage. If an employee 
(or the employee's spouse or dependent) has a significant curtailment 
that is a loss of coverage, the plan may permit that employee to revoke 
his or her election under the cafeteria plan and, in lieu thereof, to 
elect either to receive on a prospective basis coverage under another 
benefit package option providing similar coverage or to drop coverage if 
no similar benefit package option is available. For purposes of this 
paragraph (f)(3)(ii), a loss of coverage means a complete loss of 
coverage under the benefit package option or other coverage option 
(including the elimination of a benefits package option, an HMO ceasing 
to be available in the area where the individual resides, or the 
individual losing all coverage under the option by reason of an overall 
lifetime or annual limitation). In addition, the cafeteria plan may, in 
its discretion, treat the following as a loss of coverage--
    (A) A substantial decrease in the medical care providers available 
under the option (such as a major hospital ceasing to be a member of a 
preferred provider network or a substantial decrease in the physicians 
participating in a preferred provider network or an HMO);
    (B) A reduction in the benefits for a specific type of medical 
condition or treatment with respect to which the employee or the 
employee's spouse or dependent is currently in a course of treatment; or
    (C) Any other similar fundamental loss of coverage.
    (iii) Addition or improvement of a benefit package option. If a plan 
adds a new benefit package option or other coverage option, or if 
coverage under an existing benefit package option or other coverage 
option is significantly improved during a period of coverage, the 
cafeteria plan may permit eligible employees (whether or not they have 
previously made an election under the cafeteria plan or have previously 
elected the benefit package option) to revoke their election under the 
cafeteria plan and, in lieu thereof, to make an election on a 
prospective basis for coverage under the new or improved benefit package 
option.
    (4) Change in coverage under another employer plan. A cafeteria plan 
may permit an employee to make a prospective election change that is on 
account of and corresponds with a change made under another employer 
plan (including a plan of the same employer or of another employer) if--
    (i) The other cafeteria plan or qualified benefits plan permits 
participants to make an election change that would be permitted under 
paragraphs (b) through (g) of this section (disregarding this paragraph 
(f)(4)); or
    (ii) The cafeteria plan permits participants to make an election for 
a period of coverage that is different from the period of coverage under 
the other cafeteria plan or qualified benefits plan.
    (5) Loss of coverage under other group health coverage. A cafeteria 
plan may permit an employee to make an election on a prospective basis 
to add coverage under a cafeteria plan for the employee, spouse, or 
dependent if the employee, spouse, or dependent loses coverage under any 
group health coverage sponsored by a governmental or educational 
institution, including the following--
    (i) A State's children's health insurance program (SCHIP) under 
Title XXI of the Social Security Act;
    (ii) A medical care program of an Indian Tribal government (as 
defined in section 7701(a)(40)), the Indian Health Service, or a tribal 
organization;
    (iii) A State health benefits risk pool; or

[[Page 535]]

    (iv) A Foreign government group health plan.
    (6) Examples. The following examples illustrate the application of 
this paragraph (f):

    Example 1. (i) A calendar year cafeteria plan is maintained pursuant 
to a collective bargaining agreement for the benefit of Employer M's 
employees. The cafeteria plan offers various benefits, including 
indemnity health insurance and a health FSA. As a result of mid-year 
negotiations, premiums for the indemnity health insurance are reduced in 
the middle of the year, insurance co-payments for office visits are 
reduced under the indemnity plan by an amount which constitutes a 
significant benefit improvement, and an HMO option is added.
    (ii) Under these facts, the reduction in health insurance premiums 
is a reduction in cost. Accordingly, under paragraph (f)(2)(i) of this 
section, the cafeteria plan may automatically decrease the amount of 
salary reduction contributions of affected participants by an amount 
that corresponds to the premium change. However, the plan may not permit 
employees to change their health FSA elections to reflect the mid-year 
change in copayments under the indemnity plan.
    (iii) Also, the decrease in co-payments is a significant benefit 
improvement and the addition of the HMO option is an addition of a 
benefit package option. Accordingly, under paragraph (f)(3)(ii) of this 
section, the cafeteria plan may permit eligible employees to make an 
election change to elect the indemnity plan or the new HMO option. 
However, the plan may not permit employees to change their health FSA 
elections to reflect differences in co-payments under the HMO option.
    Example 2. (i) Employer N sponsors an accident or health plan under 
which employees may elect either employee-only coverage or family health 
coverage. The 12-month period of coverage under N's cafeteria plan 
begins January 1, 2001. N's employee, A, is married to B. Employee A 
elects employee-only coverage under N's plan. B's employer, O, offers 
health coverage to O's employees under its accident or health plan under 
which employees may elect either employee-only coverage or family 
coverage. O's plan has a 12-month period of coverage beginning September 
1, 2001. B maintains individual coverage under O's plan at the time A 
elects coverage under N's plan, and wants to elect no coverage for the 
plan year beginning on September 1, 2001, which is the next period of 
coverage under O's accident or health plan. A certifies to N that B will 
elect no coverage under O's accident or health plan for the plan year 
beginning on September 1, 2001 and N has no reason to believe that A's 
certification is incorrect.
    (ii) Under paragraph (f)(4)(ii) of this section, N's cafeteria plan 
may permit A to change A's election prospectively to family coverage 
under that plan effective September 1, 2001.
    Example 3. (i) Employer P sponsors a calendar year cafeteria plan 
under which employees may elect either employee-only or family health 
coverage. Before the beginning of the year, P's employee, C, elects 
family coverage under P's cafeteria plan. C also elects coverage under 
the health FSA for up to $200 of reimbursements for the year to be 
funded by salary reduction contributions of $200 during the year. C is 
married to D, who is employed by Employer Q. Q does not maintain a 
cafeteria plan, but does maintain an accident or health plan providing 
its employees with employee-only coverage. During the calendar year, Q 
adds family coverage as an option under its health plan. D elects family 
coverage under Q's plan, and C wants to revoke C's election for health 
coverage and elect no health coverage under P's cafeteria plan for the 
remainder of the year.
    (ii) Q's addition of family coverage as an option under its health 
plan constitutes a new coverage option described in paragraph (f)(3)(ii) 
of this section. Accordingly, pursuant to paragraph (f)(4)(i) of this 
section, P's cafeteria plan may permit C to revoke C's health coverage 
election if D actually elects family health coverage under Q's accident 
or health plan. Employer P's plan may not permit C to change C's health 
FSA election.
    Example 4. (i) Employer R maintains a cafeteria plan under which 
employees may elect accident or health coverage under either an 
indemnity plan or an HMO. Before the beginning of the year, R's 
employee, E elects coverage under the HMO at a premium cost of $100 per 
month. During the year, E decides to switch to the indemnity plan, which 
charges a premium of $140 per month.
    (ii) E's change from the HMO to indemnity plan is not a change in 
cost or coverage under this paragraph (f), and none of the other 
election change rules under paragraphs (b) through (e) of this section 
apply.
    (iii) Although R's health plan may permit E to make the change from 
the HMO to the indemnity plan, R's cafeteria plan may not permit E to 
make an election change to reflect the increased premium. Accordingly, 
if E switches from the HMO to the indemnity plan, E may pay the $40 per 
month additional cost on an after-tax basis.
    Example 5. (i) Employee A is married to Employee B and they have one 
child, C. Employee A's employer, M, maintains a calendar year cafeteria 
plan that allows employees to elect coverage under a dependent care FSA. 
Child C attends X's on site child care center at an annual cost of 
$3,000. Prior to the beginning of the year, A elects salary reduction 
contributions of $3,000 during the year to fund coverage under the 
dependent

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care FSA for up to $3,000 of reimbursements for the year. Employee A now 
wants to revoke A's election of coverage under the dependent care FSA, 
because A has found a new child care provider.
    (ii) The availability of dependent care services from the new child 
care provider (whether the new provider is a household employee or 
family member of A or B or a person who is independent of A and B) is a 
significant change in coverage similar to a benefit package option 
becoming available. Because the FSA is a dependent care FSA rather than 
a health FSA, the coverage rules of this section apply and M's cafeteria 
plan may permit A to elect to revoke A's previous election of coverage 
under the dependent care FSA, and make a corresponding new election to 
reflect the cost of the new child care provider.
    Example 6. (i) Employee D is married to Employee E and they have one 
child, F. Employee D's employer, N, maintains a calendar year cafeteria 
plan that allows employees to elect coverage under a dependent care FSA. 
Child F is cared for by Y, D's household employee, who provides child 
care services five days a week from 9 a.m. to 6 p.m. at an annual cost 
in excess of $5,000. Prior to the beginning of the year, D elects salary 
reduction contributions of $5,000 during the year to fund coverage under 
the dependent care FSA for up to $5,000 of reimbursements for the year. 
During the year, F begins school and, as a result, Y's regular hours of 
work are changed to five days a week from 3 p.m. to 6 p.m. Employee D 
now wants to revoke D's election under the dependent care FSA, and make 
a new election under the dependent care FSA to an annual cost of $4,000 
to reflect a reduced cost of child care due to Y's reduced hours.
    (ii) The change in the number of hours of work performed by Y is a 
change in coverage. Thus, N's cafeteria plan may permit D to reduce D's 
previous election under the dependent care FSA to $4,000.
    Example 7. (i) Employee G is married to Employee H and they have one 
child, J. Employee G's employer, O, maintains a calendar year cafeteria 
plan that allows employees to elect coverage under a dependent care FSA. 
Child J is cared for by Z, G's household employee, who is not a relative 
of G and who provides child care services at an annual cost of $4,000. 
Prior to the beginning of the year, G elects salary reduction 
contributions of $4,000 during the year to fund coverage under the 
dependent care FSA for up to $4,000 of reimbursements for the year. 
During the year, G raises Z's salary. Employee G now wants to revoke G's 
election under the dependent care FSA, and make a new election under the 
dependent care FSA to an annual amount of $4,500 to reflect the raise.
    (ii) The raise in Z's salary is a significant increase in cost under 
paragraph (f)(2)(ii) of this section, and an increase in election to 
reflect the raise corresponds with that change in status. Thus, O's 
cafeteria plan may permit G to elect to increase G's election under the 
dependent care FSA.
    Example 8. (i) Employer P maintains a calendar year cafeteria plan 
that allows employees to elect employee-only, employee plus one 
dependent, or family coverage under an indemnity plan. During the middle 
of the year, Employer P gives its employees the option to select 
employee-only or family coverage from an HMO plan. P's employee, J, who 
had elected employee plus one dependent coverage under the indemnity 
plan, decides to switch to family coverage under the HMO plan.
    (ii) Employer P's midyear addition of the HMO option is an addition 
of a benefit package option. Under paragraph (f) of this section, 
Employee J may change his or her salary reduction contributions to 
reflect the change from indemnity to HMO coverage, and also to reflect 
the change from employee plus one dependent to family coverage (however, 
an election of employee-only coverage under the new option would not 
correspond with the addition of a new option). Employer P may not permit 
J to change J's health FSA election.

    (g) Special requirements relating to the Family and Medical Leave 
Act. An employee taking leave under the Family and Medical Leave Act 
(FMLA) (Public Law 103-3 (107 Stat. 6)) may revoke an existing election 
of accident or health plan coverage and make such other election for the 
remaining portion of the period of coverage as may be provided for under 
the FMLA. See Sec. 1.125-3 for additional rules.
    (h) Elective contributions under a qualified cash or deferred 
arrangement. The provisions of this section do not apply with respect to 
elective contributions under a qualified cash or deferred arrangement 
(within the meaning of section 401(k)) or employee contributions subject 
to section 401(m). Thus, a cafeteria plan may permit an employee to 
modify or revoke elections in accordance with section 401(k) and (m) and 
the regulations thereunder.
    (i) Definitions. Unless otherwise provided, the definitions in 
paragraphs (i)(1) though (8) of this section apply for purposes of this 
section.
    (1) Accident or health coverage. Accident or health coverage means 
coverage under an accident or health plan as defined in regulations 
under section 105.

[[Page 537]]

    (2) Benefit package option. A benefit package option means a 
qualified benefit under section 125(f) that is offered under a cafeteria 
plan, or an option for coverage under an underlying accident or health 
plan (such as an indemnity option, an HMO option, or a PPO option under 
an accident or health plan).
    (3) Dependent. A dependent means a dependent as defined in section 
152, except that, for purposes of accident or health coverage, any child 
to whom section 152(e) applies is treated as a dependent of both 
parents, and, for purposes of dependent care assistance provided through 
a cafeteria plan, a dependent means a qualifying individual (as defined 
in section 21(b)(1)) with respect to the employee.
    (4) Disability coverage. Disability coverage means coverage under an 
accident or health plan that provides benefits due to personal injury or 
sickness, but does not reimburse expenses incurred for medical care (as 
defined in section 213(d)) of the employee or the employee's spouse and 
dependents. For purposes of this section, disability coverage includes 
payments described in section 105(c).
    (5) Family member plan. A family member plan means a cafeteria plan 
or qualified benefit plan sponsored by the employer of the employee's 
spouse or the employee's dependent.
    (6) FSA, health FSA. An FSA means a qualified benefits plan that is 
a flexible spending arrangement as defined in section 106(c)(2) . A 
health FSA means a health or accident plan that is an FSA.
    (7) Placement for adoption. Placement for adoption means placement 
for adoption as defined in regulations under section 9801.
    (8) Qualified benefits plan. A qualified benefits plan means an 
employee benefit plan governing the provision of one or more benefits 
that are qualified benefits under section 125(f). A plan does not fail 
to be a qualified benefits plan merely because it includes an FSA, 
assuming that the FSA meets the requirements of section 125 and the 
regulations thereunder.
    (9) Similar coverage. Coverage for the same category of benefits for 
the same individuals (e.g., family to family or single to single). For 
example, two plans that provide coverage for major medical are 
considered to be similar coverage. For purposes of this definition, a 
health FSA is not similar coverage with respect to an accident or health 
plan that is not a health FSA. A plan may treat coverage by another 
employer, such as a spouse's or dependent's employer, as similar 
coverage.
    (j) Effective date--(1) General rule. Except as provided in 
paragraph (j)(2) of this section, this section is applicable for 
cafeteria plan years beginning on or after January 1, 2001.
    (2) Delayed effective date for certain provisions. The following 
provisions are applicable for cafeteria plan years beginning on or after 
January 1, 2002: paragraph (c) of this section to the extent applicable 
to qualified benefits other than an accident or health plan or a group-
term life insurance plan; paragraph (d)(1)(ii)(B) of this section 
(relating to a spouse, former spouse, or other individual obtaining 
accident or health coverage for an employee's child in response to a 
judgment, decree, or order); paragraph (f) of this section (rules for 
election changes as a result of cost or coverage changes); and paragraph 
(i)(9) of this section (defining similar coverage).

[T.D. 8878, 65 FR 15550, Mar. 23, 2000, as amended by T.D. 8921, 66 FR 
1840, Jan. 10, 2001; T.D. 8921, 66 FR 13013, Mar. 2, 2001; T.D. 8966, 66 
FR 52680, Oct. 17, 2001]