A recent memorandum from the IRS Office of Chief Counsel serves as a helpful reminder to check in on cafeteria plan administration and ensure all processes—including claims substantiation for medical expenses and dependent care expenses—meet minimum standards under Code Section 125. Failure to correctly administer your cafeteria plan can result in unwanted tax consequences.
Code Section 125, and the proposed regulations thereunder, require that any and all reimbursements requested by a cafeteria plan participant be fully substantiated. This means that cafeteria plans should have processes in place to ensure that independent third parties fully substantiate all medical expense reimbursements and all dependent care assistance expenses. A lack of such processes can result in participants losing favorable tax benefits—meaning that amounts elected under the plan may be included in gross income and subject to withholding.
The memo suggests that the following methods are not sufficient to fully substantiate claims:
- Self-Certification Method: Cafeteria plans may not rely on a participant’s own certification. Substantiations that lack independent certification are insufficient, even when such certifications provide details about the expense (including, for example, the service or product, the date the expense was incurred, and the amount of the expense) or rely on debit card charge statements.
- Sampling Method: All claims must be independently substantiated. It is not sufficient to require substantiation only of a random sampling of expense claims.
- De Minimis Method: All claim amounts must be independently substantiated. Plans do not meet minimum requirements if they only require substantiation of claims above a certain threshold. Stated another way: there is no “de minimis” exception to the substantiation requirement.
- Favored Providers Method: Claims from all sources must be independently substantiated. Plans may not exempt claims from certain providers from the substantiation requirement.
- Anticipated DCA Expenses Method: Only actual expenses may be reimbursed. It is not sufficient, therefore, for dependent care expenses, to rely only on an advance estimate of expenses without additional verification.
Avoid plan operational failures by ensuring that your cafeteria plan has adequate procedures in place to require independent substantiation of all claims. As always, our employee benefits team is happy to provide further guidance.
