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What if an employee makes an Enrollment Mistake? consider this hypothetical example: IF an employee just noticed that her first paycheck for this year reflected a salary reduction for DCAP benefits. And then claims they never elected such benefits but they signed the election form that contains a DCAP election. The employee realizes a mistake was made but insists the plan sponsor fix it anyway. Can they do this under the IRS rules?

Possibly, but only if you conclude that (1) there is "clear and convincing evidence" that your employee made a mistake; (2) the mistake is of a type that can be corrected; and (3) the correction is appropriate. The permitted election changes regulations (Prop. Treas. Reg. Sec. 1.125-4) do not allow election changes for mistakes at all. But

IRS officials have informally commented that an employee's election may be undone when there is "clear and convincing evidence" of a mistake. Employers generally use two approaches for evaluating whether such evidence exists: the "impossibility" approach and the "facts and circumstances" approach.

1. Employers who use the impossibility approach allow an election change only if the evidence indicates that it was impossible for the employee to benefit from the mistaken election. (Thus, you could undo your employee’s election for DCAP benefits if you are convinced they has no “qualifying individuals” under a DCAP.) The impossibility approach is the safest and easiest to administer because plan administrators need not examine subjective employee motives, and their decisions are consequently less likely to invite IRS scrutiny.

2. Under the “facts and circumstances” approach, errors may be corrected if the plan administrator can reasonably ascertain that a mistake actually occurred. Because this approach may require inquiry into an employee’s intentions (by examining extrinsic evidence of those intentions), it is likely to be more closely scrutinized by the IRS.  You might consider adopting and consistently following written guidelines that require consideration of the following factors, among others: evidence of historical elections and benefit usage patterns (e.g., whether your employee has ever elected your DCAP in the past and/or has consistently used her spouse’s DCAP if there were qualifying individuals); plausible evidence of a clerical mistake (e.g., while an employee might easily write $5,000 instead of $500, it is harder to believe that $5,000 was written instead of $2,400); assessment of the employee’s truthfulness; proximity to the first payroll date after the new election is in force (your employee called this mistake to your attention right after her first 2004 paycheck—this is one factor arguing in favor of allowing an election change); and whether changed circumstances of the employee indicate reconsideration of a decision rather than a mistake. You must also obtain a signed certification from the employee describing the mistake and the intended election (e.g., if they intended to elect benefits under the health FSA instead, as they has historically done, the appropriate correction would be election of such benefits). To reduce the possibility of challenges to the “facts and circumstances” approach, plan administrators may also wish to consider adopting additional guidelines, such as a time limit (e.g., 30 days after the close of the first payroll period) within which requests for changes in mistaken elections must be made.

Under either approach, so long as the "clear and convincing" standard is met, clerical, arithmetic and data entry errors by employees may be corrected retroactively. But mistakes as to the scope of a benefit or the tax treatment of a benefit cannot be corrected at all. (Thus, you could not permit your employee to change her election just because they mistakenly believed that the DCAP provided more tax savings than did the dependent care tax credit.) The IRS has indicated that it will formally address mistaken elections when the proposed cafeteria plans regulations are finalized--such guidance will be most welcome.

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