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November 30, 2011

Re: Division of Local Government Services Issues Additional Guidance on c. 78 Health Benefit Reforms

Dear Mayor:

The Division of Local Government Services has issued Local Finance Notice 2011-34 providing supplemental guidance on the 2011 Health Benefit reforms.  The finance notice summarizes and supplements Local Finance Notice 2011-20R, which replaced Local Finance Notice 2011-20.

The notice includes the following guidance:

Employees Changing Organizations
If an employee is transferred or assigned to another government employer through an agreement between employers (i.e., shared services, inter-government transfer, service consolidation, etc.), and the work being performed is effectively continuous, the change would not trigger a break in employment and the employee would not be treated as a new employee for c.78 purposes.

Calculation of Premiums for Self-Insured Programs
An employer that provides a benefit on a self-insured basis must develop a premium or periodic charge for each self-insured benefit provided to employees in order to calculate the total benefit costs under section 39.  The calculation guidance under “Impact on Local Unit Self Insurance Programs” in Section 2 of LFN 2011-20R continues to apply for the calculation or premiums or periodic charges.

Employees who are on Workers’ Compensation, Disability or Family Leave
During the period in which they are not actively at work, these employees should continue to contribute as if they were receiving their regular salary. The appropriate health care contribution method and amount under c. 2, c. 78 or a greater local contribution requirement would continue based on their pre-leave salary.  All adjustments to the contribution amount, due to increased coverage costs or employee salary changes, would take effect as if the employee continued in active service.

Supplemental Information on Section 125 Plan Issues Pre-Funding Flexible Spending Accounts
All public employers must now establish Section 125 Flexible Spending Accounts to allow employees the option of using pre-tax dollars to satisfy their required contributions to health benefits costs under c. 78, PL 2011.  See Local Finance Notice 2011-20R for basic information about these plans and complying with the statute. 

Local employers need to be aware that a Flexible Spending Account (FSA) may require an employer to pre-fund a portion of the employee accounts at the inception of the program and annually at the beginning of each plan/budget year.  The pre-funding is necessary to have funds available to pay/reimburse claims during the initial period until employee salary deductions are sufficient to pay these claims.  IRS rules require that the full amount of an employee’s annual deduction be available for use at any time as of the first day of the plan/budget year, regardless of the amount actually contributed by the employee.  The employer is not required to actually fund the entire annual amount for each employee, only to provide an amount to cover anticipated claims during the initial period.  It is unlikely that many, if any, employees will require the full amount of their annual contribution early during the coverage period.  An initial amount may be repaid by the plan provider once sufficient funds are accumulated through the deduction process.  Regardless, in the event the program needs pre-funding, an interfund transfer is the appropriate method of providing the short-term funding for the program to be operational.  The transfer should be reversed once the fund achieves a level sufficient to maintain itself.

At the employer’s discretion, the plan may include a grace period of up to two and a half months after the end of the plan year.  If there is a grace period, any qualified medical expenses incurred during that period can be paid from any amounts left in the employee’s account at the end of the previous year.  At the end of the plan/budget year the employer retains the unexpended balance of the employees’ contributions.  These monies can be used in the subsequent year as pre-funding to cover the initial expenses of that year, allocated to pay the employer’s administrative costs, or to recoup the pre-funding amount advanced at the start of the year.  The employer is not permitted to refund any remaining balance to the employees.  It is important to note that the full amount of an employee’s annual contribution can be used at any point in the year.  If this occurs during the initial period, the entire amount could be claimed.  If the employee does not return to work or is terminated, he does not have to repay the money to the employer.

Under the FSA (and the Premium Option Plan that is also required by c. 78), both the employee and the employer benefit from the pre-tax treatment of the monies.  Payroll taxes (Federal Income Tax, Social Security Tax and Medicare) are not paid on the portion of salary deposited into the FSA.   The means the employer appropriation for FICA and related taxes can be reduced by the taxes that would otherwise accrue to the employer by the anticipated FSA deductions for the year.

Together, the retained balance at the end of the plan year, plus the savings in employer payroll tax obligation is expected to offset the costs of providing the plan and any losses from employees who use their entire contribution and terminate employment prior to the end of the year.  Based on this, the law anticipates that the employer will bear the costs of providing the plan.

The Division may issue further guidance through GovConnect and DLGS E-Mail News

Very truly yours,


William G. Dressel, Jr.
Executive Director






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