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IRS Clarifies the Rules for Disposal of Cafeteria Plan Forfeitures

On Behalf of | Mar 23, 2017 |

The IRS has issued guidance on the rules for disposing of unused funds in a cafeteria plan where the plan’s sponsor discontinues its business operations. In Information Letter 2016-0077, the IRS responds to a taxpayer’s inquiry by confirming that the unused funds will not revert to the U.S. Treasury but are instead disposed of in accordance with the plan document.

Background. Regulations issued under Internal Revenue Code Section 125 provide the requirements for disposing of unused funds forfeited by a participant under an ongoing plan. Under these rules, forfeitures may be:

  • Retained by the employer maintaining the plan,
  • Used to defray plan expenses, or
  • Returned to employees (i.e., current plan participants) and allocated on a reasonable and uniform basis.

The regulations, however, do not address a situation when the plan sponsor ceases business operations.

Facts. An employee had been making regular contributions to his former employer’s cafeteria plan through the time of his termination when the employer went out of business. The cafeteria plan document provided that: (i) eligible health care expenses incurred by an employee before his or her termination of employment could be reimbursed; and (ii) any unused funds reverted to the plan to pay expenses.

Although the employee had unused funds in his cafeteria plan account at the time of his termination of employment, he did not have unreimbursed health care expenses. After being told that because his former employer went out of business, the unused funds would default to the U.S. Treasury, the employee contacted IRS to request that it confirm whether this was true. IRS responded by issuing the Letter.

IRS Letter. The IRS first explained that the cafeteria plan document at issue required the forfeiture of any unused funds upon an employee’s termination unless the employee had reimbursable health care expenses on or before the termination of employment and submitted a claim within 60 days of the termination date.

It then confirmed that the cafeteria plan document’s provisions were consistent with the requirements of Code Section 125, which provide that unused cafeteria plan contributions must be forfeited after an employee terminates employment (and no longer participates in the cafeteria plan).

The IRS concluded by clarifying that nothing in the law requires the forfeited amounts to default to the U.S. Treasury in the context of a cafeteria plan termination. Rather, the disposal of unused funds in a terminated cafeteria plan would still be dependent on plan provisions (as interpreted by the plan administrator) under the facts and circumstances at the time of plan’s termination.

IRS Information Letter 2016-0077 is available at: