The design and operation of cafeteria plans: the flexibility of benefits choice can enhance employee moral and after-tax income.

The Flexibility of Benefits Choice Can Enhance Employee Morale and After-Tax Income

Cafeteria plans are a popular mechanism to provide fringe benefits to employees. They can be relatively simple, perhaps offering only the choice of cash or health insurance, or more complex, offering a wide variety of benefit options. To assist tax advisers and their clients in evaluating key aspects of existing plans or designing new plans to maximize the benefit to the employer and the employees, this article will discuss the design of key benefits, the structure of flexible spending accounts (FSAs) to minimize employer and employee risk of loss, and the essential administrative issues arising in the adoption and operation of a cafeteria plan.

Overview

Sec. 125(a) provides that a participant in a cafeteria plan can choose between the receipt of cash or qualified benefits without having to recognize income solely because of the ability to choose. Without Sec. 125, an employee given a choice between cash or the purchase of a fringe benefit would generally be considered to be in constructive receipt of the cash, even if the fringe benefit was selected. A cafeteria plan is one mechanism to permit such a choice without creating a constructive receipt problem.(1) If the plan is properly structured, employees selecting tax-free benefits will pay with pretax dollars, and those choosing cash will be taxed in the year of receipt.

The principal advantage of a cafeteria plan to employees is the ability to choose from a menu of offerings those benefits that are of greatest value to the individual. Employer administrative costs generally constrain the number of available choices. Noncash benefits selected by employees are exempt from Fedcral income tax,(2) and may also be exempt from state income tax. In addition, FICA taxes can generally be avoided for all benefits other than salary reduction contributions to a Sec. 401(k) plan.(3) The ability to avoid income and FICA taxes can make a cafeteria plan attractive to employees even if the plan limits the choice to cash or health insurance coverage. Of course, avoiding FICA taxes may not appear attractive to employees concerned about reduced social security payments in future periods.

Employers benefit from cafeteria plans to the extent that benefits choice enhances the ability to attract, retain and motivate employees. Adoption and operation of a plan will create administrative costs, but payroll tax savings for employer-paid FICA can assist in reducing these costs. Employer FUTA taxes can also be avoided, although employee wages are likely to exceed the maximum contribution base without the value of the fringe benefit.(4) Offering health benefits through a cafeteria plan increases employee awareness of the cost of the benefit, which can assist in containing costs. Finally, retirement plan contributions can be reduced, depending on how the compensation base for contributions is defined. Of course, the effect of reduced retirement contributions on employee satisfaction with the overall benefits package must be considered.

To qualify under Sec. 125, the plan must be in writing,(5) be limited to employees(6) and offer participants a choice between cash and qualified benefits.(7) Highly compensated participants are not eligible for protection from constructive receipt if the plan is discriminatory as to either eligibility to participate or contributions and benefits.(8) Also, key employees fail to qualify for the constructive receipt waiver if the concentration of nontaxable benefits provided to such employees exceeds 25 % of the aggregate nontaxable benefits provided to all employees.(9) Any nondiscrimination provisions applicable to a particular benefit must also be satisfied for the benefit selection to be nontaxable.

Structuring a Cafeteria Plan

Since the principal advantage of a cafeteria plan is the ability to tailor benefits to employee needs, it is important to select carefully which benefits to offer. The starting point is the menu of available choices, which includes any benefit excluded from income other than scholarships, educational assistance plans and Sec. 132 fringe benefits.(10) Sec. 401(k) plan contributions are the only permitted form of deferred compensation.(11) A simple plan could offer only cash or health insurance, permitting employees to purchase a needed benefit with pretax (income and payroll) dollars and minimizing the employer's administrative cost. If the employer can offer more choices, a survey of employee needs will assist in selecting benefits to include in the plan. Preferences of highly compensated and key employees should be separately identified when designing the choices to ensure that the plan does not fail the nondiscrimination or concentration tests.

* Health care benefits

Health benefits are a popular choice among employees, and thus are a logical benefit to be offered in the cafeteria plan. As mentioned earlier, offering a trade-off between health coverage and other benefits involves the employee in the cost of the health coverage, and can assist in controlling escalating costs. When communicating the effects of a choice of health insurance coverage in a plan, the employer should make employees aware of the Revenue Reconciliation Act of 1990 (RRA) amendments to the earned income credit, providing for a supplemental health insurance credit. The credit is available only for the cost of health insurance coverage that includes a qualified child.(12) The employee should be aware that the credit is not available for any costs paid for with pretax dollars.

* Dependent care assistance benefits

Sec. 129 permits an exclusion from income for employer-provided dependent care payments. The exclusion can be as large as $5,000, and applies to expenses incurred for the care of a dependent of the taxpayer who is under age 13 or for a dependent or spouse who is physically or mentally incapable of taking care of himself. The dependent care credit provisions place restrictions on who can be the care provider and set requirements for identifying the care provider. The exclusion is limited to the lesser of the earned income of the taxpayer or the taxpayer's spouse. The earned income limitation also applies to a spouse who is a student or incapable of his own care.(13)

Because Sec. 129(d)(4) denies the exclusion if more than 25% of the benefits are provided to more-than-5% owners of the business, a dependent care program is not likely to be beneficial in a closely held corporation if the purpose is to meet the needs of the principal owner. The benefit may still be offered in the cafeteria menu, but the principal owner may need to limit participation to avoid failing the concentration test.

Example 1: R is the sole owner of a C corporation with five employees, each of whom would be interested in dependent care assistance. R typically incurs $6,500 of dependent care expenses each year. If the other employees select an aggregate of $9,000 of dependent care assistance payments (an average of $1,800 per employee), R can allocate as much as $3,000 of his salary to dependent care. Total dependent care benefits would be $12,000, and R would not receive more than 25% of the benefits paid.

Employer communication to participants should include the interaction of the exclusion with the Sec. 21 dependent care credit. The maximum expenses eligible for the credit are reduced dollar-for-dollar by any payments eligible for the exclusion.(14) Each employee must decide whether the credit or the exclusion is of greater value.

In theory, the choice between the credit and the exclusion is a relatively simple one. The dollar value of the credit is determined by multiplying the credit rate, ranging from 20% to 30%, by the amount of eligible expenses. The value of the deduction is the product of the taxpayer's marginal tax rate and the amount of eligible expenses. Eligible expenses are defined similarly for the credit and the exclusion, but under Sec. 2 1 (c) the limitation for the credit is $2,400 for one dependent or $4,800 for two or more dependents, while the exclusion limitation is $5,000. The employee's decision should be based on a comparison of the credit rate with the marginal tax savings of the exclusion, which includes the sum of Federal income taxes, state income taxes (if no adjustment is made to the Federal tax basel and FICA taxes. The credit rate is a sliding scale based on adjusted gross income (AGI) and falls below 28% if AGI exceeds $14,000. A taxpayer in the 28% Federal bracket would have AGI in excess of $14,000, and would thus prefer the exclusion even if there are no state income tax or FICA savings available. Taxpayers in the 15% Federal bracket are likely to be subject to the full 7.65 % FICA tax, and may also enjoy state income tax savings from the exclusion.(15) The credit rate must then be compared to the sum of the rates of any taxes that can be avoided if the exclusion is claimed.

Example 2: M incurs $4,500 of qualifying expenses for the care of her two dependent children. M is in the 15% Federal tax bracket for a range of income (including the $4,500 possible exclusion), and is subject to 7.65% FICA taxes and a 3% state income tax. Based on AGI without the exclusion for dependent care, M is eligible for a 24% child care credit. The exclusion would save M 25.65% of eligible expenses and the credit would save 24%. Thus, M will be better off by claiming the exclusion, saving $74 (1.65% of $4,500). A $4,500 reduction in AGI could also save other taxes.

Example 3: Assume the same facts as in Example 2, except that M lives in a state that does not assess an income tax. The exclusion would then save only 22.65% of eligible expenses, and the credit would benefit M by $61, relative to the exclusion (1.35% of $4,500). However, M should ensure that there are no other tax savings available if AGI were reduced by the exclusion.

Employers should be aware of the trade-off between the credit and the exclusion for two reasons. First, the employer could assist the employee in making an informed choice, perhaps by providing a worksheet comparing the choices. Second, the exclusion is available to more-than-15% owners only if the nondiscrimination and concentration tests do not fail. Because the owners are likely to be in a high tax bracket, the exclusion should be more valued than the credit to such employees, and the employer may need to sweeten the deal to some extent to encourage participation of nonowners.

Example 4: Assume the same facts as in Example 3. In addition, M is the only employee other than the owner of the business. The owner-employee can save 35.65% of all dependent care payments eligible for the exclusion, but only 20% through the credit. The corporate employer can also save the employer FICA for any expenses eligible for the exclusion. Thus, the owner-employee has an economic incentive to encourage M to use the exclusion. M's salary could be increased if the exclusion is used, perhaps by reimbursing more than one dollar for every dollar of eligible expenses. The incremental salary would be fully taxed and must be large enough to overcome the $61 (computed in Example 3) advantage available from the credit. If the owner increases M's salary by $450 (representing a 110 % expense reimbursement), M will net an additional $348 after payment of Federal income tax and FICA tax, and the overall arrangement will save her $287 ($348 - $61). The owner-employee could participate in the plan for as much as $1,500 in expenses (total expense reimbursements would be $6,000, and the owner-employee would receive 25% of the total), and save $235 on his personal taxes (15.65% of the reimbursement) by taking the exclusion rather than the credit. The corporate employer would save FICA taxes for $5,550 of total wages ($6,000 - M's $450 salary increase), deduct the $450 salary increase provided to M and realize a net cash inflow from the salary increase.

In addition to the trade-off between the dependent care exclusion and credit, employers should inform employees that the RRA of 1990 permits a supplement to the earned income credit for a child under the age of one at the end of the tax year.(16) If the supplemental credit is claimed, no dependent care credit or dependent care exclusion is available for expenses attributable to that child. Because the supplemental credit cannot exceed 5%, its use should be limited to situations in which the employee's income is so low that there is no tax advantage associated with either the dependent care credit or exclusion,(17) or eligible care is for more than two dependents. In such cases, the employee-parent should certify that any reimbursed expenses for which the exclusion is claimed do not relate to a child for whom the supplemental credit is to be claimed.

Example 5: I has three children, ages six months, three years and five years. I incurs $8,000 of dependent care expenses during the tax year, $3,000 of which relates to care of the six-month-old. The expenses can be separately identified by child and I qualifies for the earned income credit. I can receive $5,000 of reimbursements eligible for the dependent care exclusion, or can claim a dependent care credit for as much as $4,800 of expenses. If I requests a $5,000 employer reimbursement to take advantage of the dependent care exclusion, he should document that the reimbursement does not relate to the care of the six-month-old. Presumably, the $5,000 exclusion can apply to the care of the older children and the supplemental earned income credit is still available for the expenses associated with the six-month-old.

* Purchase and sale of vacation time

A cafeteria plan can provide employees with the option to purchase or to sell vacation time.(18) This option can be attractive to both employer and employee, because the administrative cost of accounting for changes in vacation time may be relatively low, and the increased leisure time is seen as a valued benefit. If an employee's absence would be detrimental to the firm, that employee could be prohibited from buying additional vacation days or could be charged a higher toll for the purchase. For example, certain employees could be offered the opportunity to purchase or sell vacation days on a dollar-for-dollar basis, while others could only sell for $0.80 per dollar or purchase for $1.25 per dollar. The employer could set any exchange rate that is considered appropriate to achieve the overall objectives of the plan, provided the plan does not discriminate in favor of highly compensated employees.

The purchase and sale of vacation time must be structured to avoid the statutory prohibition against offering deferred compensation in a cafeteria plan. If an employee can purchase additional vacation days, the ability to carry over unused days to the next year provides a mechanism to defer the compensation used to purchase the carryover days. Thus, "elective" vacation days purchased by an employee cannot carry over to the next year. Nonelective days are deemed to be used first and unused elective days can be cashed out at the end of the year, since cash payment would subject the employee to current year taxation and thus not defer compensation.(19) However, cashing out unused days imposes an administrative burden on the employer to identify the use of vacation time on a timely basis.

Example 6: E receives two weeks of vacation each year, but is also entitled to purchase up to two additional weeks. During the current year, E purchases two additional weeks, and uses a total of three vacation weeks. The two nonelective weeks are treated as used first, with the result that the unused week is elective (purchased) and cannot be carried forward. E can receive cash for the value of the unused week, if paid before the end of the year.

Example 7: Assume the same facts as in Example 6, except that E uses only one week of vacation. Two of the remaining three weeks are considered to be elective weeks, and cannot be carried forward. One remaining week is nonelective, and can be carried forward because it is not a benefit offered through the cafeteria plan.

The IRS has taken the position that the ability to sell vacation days in a cafeteria plan means that any days that could have been sold are elective days. Thus, such days must be used by the end of the year, cashed out or forfeited.

Example 8: I is provided with two weeks of vacation each year, and is entitled to sell up to one week of vacation time under the terms of a cafeteria plan. The option to sell converts the week from a nonelective one to an elective one, subject to potential forfeiture.

* Flexible spending arrangements

An FSA is a benefit program permitting the participant to be reimbursed for specified expenses that are properly documented to the employer. The maximum permitted reimbursement cannot substantially exceed the premium (employer and employee) contributions made. The regulations indicate that reimbursements that are less than 500% of the premium are acceptable.(20) An FSA is typically funded with elective salary reduction contributions by the employee, which are then used to reimburse expenses such as health care and dependent care. The contributions are exempt from FICA and Federal income taxes, and perhaps state income taxes.

Example 9: K's employer offers an FSA, which permits allocations of employee salary reduction contributions to a health care account and a dependent care account. K elects to contribute $1,200 to the health care account and $3,600 to the dependent care account. As K incurs expenses that are not reimbursed from some other source, she submits documentation to the employer and is reimbursed. K pays qualified expenses with pretax dollars, and the employer also saves FICA taxes for FSA contributions.

FSAs operate under a use-it-or-lose-it principle that shifts economic risk to the employee in exchange for a tax benefit. Because the contributions to the FSA are pretax, to prevent using the FSA as a device to defer compensation, an employee cannot carry forward unused amounts to a subsequent tax year. Moreover, FSAS cannot offer an option to cash out unused contributions at year-end. Dependent care reimbursement accounts create limited risk because such expenses can often be estimated with accuracy. Health care expenses are more difficult to estimate, and the employee risks forfeiture of contributions in excess of reimbursements.

Example 10: Employee E allocates $1,200 to a health care reimbursement account and $3,600 to a dependent care account. The dependent care allocation is based on a known fee charged by a dependent care provider, such that the entire account is expected to be spent in the current year. If the provider should increase the fee during the year, E must pay the excess with after-tax dollars (which would be eligible for the dependent care credit), but the year will not end with an unused balance in the account unless the expected fee or use is reduced. The health care allocation is based on expected expenses after considering reimbursements from an insurance provider. Actual expenses could significantly differ from the estimate, and there is a risk of loss if expenses are less than the expected $1,200.

A health-care FSA account must cover a period of 12 months, and can reimburse only previously incurred expenses that are documented by a third-party care provider and qualify as deductible medical expenses under Sec. 213.(21) The latter restrictions exist to prevent the use-it-or-lose-it restriction from being circumvented with either prepayments or nonqualified health-related expenditures.

Example 11: Employee M allocates $1,200 to a health-care FSA, and in the last month of the year the account has $80 that has not been spent. To avoid forfeiting this amount, M might ask his employer to prepay an expected future medical expense or he could request reimbursement for health-related items such as nonprescription drugs. These alternatives are prohibited in a health-care FSA, thus increasing M's risk of forfeiture.

Employers should ensure that their employees understand the risk of loss associated with FSA allocations. The benefit of a payment with pretax dollars must be weighed against the cost of forfeiture of unused allocations. The benefit of an FSA is the avoidance of tax (income and FICA) on amounts actually used for reimbursements. The cost of forfeited allocations is the amount allocated reduced by the tax savings realized by the contribution. If the employee's marginal tax rate is less than 50% (including FICA taxes), the opportunity cost of a one dollar underallocation (the marginal tax rate) is less than the cost of forfeiting a one dollar overallocation (one minus the marginal tax rate). The employee should then generally allocate an amount less than the estimated expense for expenses that cannot be estimated with certainty.

Example 12: Employee O's Federal income tax, state income tax and FICA tax rates total 40%. For every dollar allocated to a health-care FSA account, O avoids 40 cents in tax. If reimbursable expenses exceed the contributions to the account (an underallocation), O incurs an opportunity cost of 40 cents per dollar. This is the cost associated with payment of expenses with after-tax rather than pre-tax dollars. If O's contributions exceed reimbursable expenses (an overallocation), he loses 60 cents for every unused dollar. This is the forfeited dollar reduced by the tax savings created by the pretax contribution. Since the cost of an underallocation (40 cents per dollar) is less than the cost of an overallocation (60 cents per dollar), O should prefer an underallocation and contribute less to the FSA account than the expected expenses. If future tax rates rise above 50% (with FICA), an underallocation is more costly than an overallocation, and the strategy is reversed.

The analysis in Example 12 is limited to expenses that are subject to estimation risk. Practitioners should also consider the employee's ability to control (accelerate or defer) the timing of qualified expenses. If the employee has made an overallocation to a health-care FSA, items such as prescription eyewear or dental and medical checkups might be accelerated before year-end. An underallocation might be corrected by deferral of nonessential qualified care.

The employer must also bear a risk of loss for health-care FSAs under the "uniform coverage" requirement. Typically, annual salary reduction contributions to an FSA will occur with each pay period. For health-care FSAs, the employer must make the full annual contribution available to the employee at all times during the 12-month coverage period.(22) The uniform coverage provision does not apply to dependent-care FSA accounts.(23) If an employee terminates employment, or changes the FSA contribution election before year-end, the employer can suffer a loss if reimbursements exceed aggregate contributions as of the date of change. When employees pay medical insurance deductibles early in the year, the total annual unreimbursed costs are front-ended, increasing the employer's risk of loss when employees terminate employment before year-end.

Example 13: Employee E expects to incur $4,000 for medical care during the year and to pay a $500 deductible and a 20% co-payment for expenses above the deductible. Thus, E estimates total costs to be $1,200 ($500 + (0.20 x $3,500)). E allocates $1,200 to a health-care FSA account, which will be funded with a $100 contribution each month. In the first six months of the year, E incurs $2,000 of medical expenses and makes unreimbursed payments of $900 ($500 + (0.20 x $2,000)). Six months into the year, the contributions to the health-care FSA are only $600, but E's employer is required to reimburse the full $900. If E terminates employment after six months of coverage, his employer risks loss of the $300 excess reimbursement.

Several alternatives exist to minimize employer risk of loss associated with the uniform coverage standard. The plan could permit continued coverage for the remainder of the year following a separation from service. In Example 13, the employer would make up the $300 difference if the employee continues coverage for the last six months of the year. Under the Consolidated Omnibus Budget Reconciliation Act of 1985 (COBRA), most employers are required to provide continued health care coverage to employees who separate from service. Forcing the employee to pay for excess reimbursements from his final pay-check is risky because this practice can violate COBRA continuation coverage provisions.(24) Requiring prepayment of FSA contributions does not reduce risk because the employer must reimburse the employee for payments attributable to a postseparation period regardless of the amount of reimbursements made as of the date of separation.(25) The employer could use experience gains from other employees with account contributions in excess of reimbursements to reduce the loss.(26) The employer could also limit the maximum amount of reimbursements available under a health-care FSA or reimbursable expenses could be defined to exclude large expenses that can be planned by the employee.

Example 14: Employee P knows that she must spend $3,000 for orthodontia care for her child; she also expects to incur an additional $1,200 of unreimbursed medical expense. P would be expected to increase her "normal" annual FSA allocation by $3,000 in the year of the orthodontia care, and should defer the timing of the work until the FSA allocation can be increased. Because the care could then be expected to be provided in the early part of the year, P's employer could incur a substantial loss if P separates from service shortly after reimbursement for the orthodontia care.

Because risk of loss is increased for larger expenses that can be preplanned, the employer in Example 14 could exclude orthodontia care and similar expenses from the definition of reimbursable expenses. However, it is necessary to consider the effect that this would have on employee satisfaction with the plan. A dollar limitation on permitted reimbursements may achieve the same result without appearing to target specific types of care.

In addition to separation from service, the employer could bear a risk of loss if the plan permits employees to change coverage elections for specified changes in family status.(27) If an employee reduces contributions following a permitted change, the total contributions during the plan year could be less than reimbursements even if the employee is covered during the entire period. It is unlikely that a coverage change would be undertaken to create a financial loss to the employer because the employee would not jeopardize the future employment relationship. Thus, this type of risk is of less concern than separation from service before year-end, and there may be no need to address the risk by restricting coverage changes in the plan.

Recent Administrative Issues

The Tax Reform Act of 1986 extended the Sec. 6039D fringe benefit plan reporting requirements to cover additional benefits. It also added reporting requirements for highly compensated employees. These extensions were necessary to enforce compliance with the newly enacted Sec. 89 nondiscrimination requirements. However, when Sec. 89 was repealed, no changes were made to the revised reporting requirements, which are effective for post-Dec. 31, 1988 tax years. The IRS has announced that the expanded reporting requirements, including the highly compensated employee information for cafeteria plans, will not apply until further guidance is issued.(28) The Department of Labor has also announced that the Employee Retirement Income Security Act of 1974 (ERISA) reporting and disclosure requirements for cafeteria plan sponsors and fiduciaries will be suspended until Dec. 31, 1993, or the issuance of final regulations on the application of ERISA to cafeteria plans.(29) Until further notice, salary reduction contributions need not be held in trust under ERISA provisions.

Conclusion

Surveys of small companies (with less than 500 employees) indicate that less than one-third offer employees cafeteria plan benefits choice. Because cafeteria plans can be structured to offer only one noncash choice, such as payment of medical premiums with pretax dollars, the costs of implementing a cafeteria plan may be lower than many clients believe. Employee salary reduction allocations to purchase cafeteria benefits can save the employer FICA taxes, and perhaps reduce retirement plan contributions, depending on how compensation is defined under the plan. The flexibility of cafeteria plan choice can enhance employee morale while also increasing employees' after-tax income by reducing Federal income and FICA taxes. Clinton administration proposals to mandate health care benefits could increase the value of planning for nonhealth benefits, as employers seek to maximize the value of their overall benefits package in meeting company goals. Legislative requirements to offer a specific set of health benefits will force self-interested employers to respond with more efficient packaging of other benefits. Thus, it need not be expected that the popularity of cafeteria plans will decrease under some form of national health coverage, although the available benefits choices could change. CPAs may find that assisting clients in designing and implementing cafeteria plans is an excellent way to expand their practice. And those already active in benefits design may find opportunities to redesign existing cafeteria plans after a final form of national health coverage is enacted.

(1) See Prop. Regs. Sec. 1.125-1, Q&A-9, for a discussion of how constructive receipt applies to benefits offered in a nondiscriminatory cafeteria plan. (2) An exception would be the value of group-term life insurance coverage in excess of $50,000. (3) Sec. 3121 (a)(5)(G). (4) Sec. 3306 (b)(5)(G). (5) See Prop. Regs. Sec. 1.125-1, Q&A-3, for a discussion of the information that must be included in a written plan. (6) See Prop. Regs. Sec. 1.125-1, Q&A-4, for a definition of employees. (7) Sec. 125(d). (8) Sec. 125 (b)(1). (9) Sec. 125(b)(2). Key employees are defined in Sec. 416(i); highly compensated employees in Sec. 125(e). A safe harbor exists for health benefits. (10) Sec. 125(f). Because spouse and dependent group-term life insurance coverage not in excess of $2,000 qualifies as a de minimis fringe benefit under Sec. 132, it should not be offered in a cafeteria plan. See Notice 89-110, 1989-2 CB 447. (11) Sec. 125(d)(2)(B). (12) Sec. 32(b)(2). (13) Sec. 21 (d). (14) Sec. 21(c). (15) The availability of any state tax credit for dependent care expenses must also be considered. (16) See Sec. 32(b)(1)(D). (17) Since the earned income credit is refundable, a benefit may still be available for a supplement to the credit. (18) Prop. Regs. Sec. 1.125-2, Q&A-5(c)(1) (19) State law should be consulted to ensure there is no prohibition against forfeiture of unused vacation days, as in California. If such a prohibition exists, the employer must be particularly careful to cash-out unused elective days before year-end. (20) Prop. Regs. Sec. 1.125-2, Q&A-7(c). (21) Prop. Regs. Sec. 1.125-2, Q&A-7(b)(3)-(5). The written substantiation requirements for qualified medical expenses may exclude reimbursement for personal transportation expenses, which would otherwise qualify for a Sec. 213 deduction. (22) Prop. Regs. Sec. 1.125-2, Q&A-7(b)(2). (23) Prop. Regs. Sec. 1.125-2, Q&A-7(b)(8). (24) COBRA requires continued coverage without a change in terms. If future period contributions are withheld from the final paycheck, the employee no longer has the right to reduce coverage for permitted changes in family situations, and the payment schedule has changed. See Sec. 498OB(f). COBRA payment schedule requirements may also be violated. State labor law may also restrict the ability to withhold sums from a final paycheck. (25) Prop. Regs. Sec. 1.125-2, Q&A-7(b)(2). (26) Prop. Regs. Sec. 1.125-2, Q&A-7(b)(7). (27) Prop. Regs. Sec. 1.125-2, Q&A-6(c). (28) Notice 90-24, 1990-1 CB 335. (29) ERISA Technical Release 92-01 (6/1/92).