Can a state-employee flexible benefits program offer a pre-tax medical spending account without duplicating the State Health Plan and thus violating the duplication ban?

Plain-English summary

In 1995, Governor Hunt issued Executive Order 66 establishing NC Flex, the Statewide Employee Flexible Benefits Program. Coopers and Lybrand's study of the program raised a concern: could NC Flex offer a pre-tax medical spending account (MSA) without violating two statutes that prohibited the flex plan from duplicating certain benefits?

State Personnel Director Ronald G. Penny asked the AG to resolve the question. Senior Deputy AG Ann Reed, joined by Special Deputy AG Alexander McC. Peters, concluded that an MSA could be offered on a pre-tax basis without violating either prohibition.

The two operative statutes were G.S. 116-17.2 and G.S. 143-34.1(d). Both excluded from NC Flex coverage "those benefits provided to employees and officers under Articles 1, 3, and 6 of Chapter 135 of the General Statutes" (with § 143-34.1(d) also referencing Article 1A of Chapter 120, the Legislative Retirement System). The four programs swept in by those Articles were the Legislative Retirement System, the Teachers' and State Employees' Retirement System (TSERS), the Teachers' and State Employees' Comprehensive Major Medical Plan (the State Health Plan), and the Disability Income Plan (DIP). These are mandatory, employer-funded basic benefit plans; the prohibition existed so NC Flex would not channel employee money into duplicative private alternatives.

The AG's analysis focused on what an MSA actually does versus what the State Health Plan provides. The State Health Plan provides direct medical benefits (covered services, paid claims). An MSA provides reimbursement for out-of-pocket expenses (deductibles, co-insurance, co-payments) and for items the State Health Plan does not cover. An MSA fills gaps, it does not duplicate. That structural difference let the MSA fit into NC Flex without running into the duplication prohibition.

The AG also addressed a related Coopers and Lybrand concern that G.S. 135-40(c) and (d), which let employee-paid premiums for the State Health Plan flow through payroll deduction on a pre-tax basis, somehow blocked NC Flex from offering any other medical benefit on a pre-tax basis. The AG rejected that reading. The duplication prohibition in §§ 116-17.2 and 143-34.1(d) applies to actual direct benefits provided in the specified Articles, not to incidental administrative features like the pre-tax payroll deduction mechanism. Reading § 135-40(c)-(d) as a ceiling on pre-tax payroll deduction across all state-employee benefits would have read words into the statute that the General Assembly did not put there.

The AG also acknowledged a separate request for an opinion on the same question from Evelyn Terry, counsel to the State Health Plan. The opinion's reasoning was framed to address both requests.

Currency note

This opinion was issued in 1995. Subsequent statutory amendments, court decisions, or later AG opinions may have changed the analysis. Treat this page as historical context, not current legal advice. Verify current law before relying on any specific rule, deadline, or remedy mentioned here.

NC Flex has continued to operate and evolve. The State Health Plan has been restructured. G.S. 135-40 has been amended substantially, and the State Health Plan provisions are now in Article 3B of Chapter 135. The Office of State Personnel has been renamed the Office of State Human Resources. Federal law on flexible spending accounts and high-deductible health plans (HSAs) has developed considerably. Anyone analyzing an NC state-employee MSA or FSA question today should pull the current Chapter 135, the current G.S. 116-17.2 and G.S. 143-34.1(d), and the current IRS rules on FSAs and HSAs.

Common questions

Q: What is a medical spending account?
A: A pre-tax account into which an employee contributes a portion of pay (deducted before federal and state income tax), and from which the employee can be reimbursed for qualifying out-of-pocket medical expenses during the plan year. Federal tax rules (then under Section 125 of the Internal Revenue Code, "cafeteria plans") govern the eligibility and use rules. An MSA in this 1995 context is closer to what is now called a flexible spending account (FSA); the modern HSA is a different but related instrument tied to high-deductible health plans.

Q: What is NC Flex?
A: The state-employee flexible benefits program, established by Executive Order 66 in 1995. It lets employees use pre-tax dollars to buy various optional benefits (group dental, vision, life insurance, MSA, etc.). The State Health Plan, TSERS, and DIP are not part of NC Flex; they are the mandatory baseline. NC Flex sits on top.

Q: Why did the General Assembly bar NC Flex from duplicating the basic benefits?
A: Two reasons. First, the State is the substantial funder of TSERS, the State Health Plan, and DIP through employer contributions. Letting NC Flex divert employee pre-tax dollars to a private duplicate of the State Health Plan would undermine the cost base of the public plan. Second, employees benefit from having clear, simple, mandatory baselines plus optional extras, not from being asked to choose between multiple plans offering the same core coverage.

Q: What is the difference between a "direct benefit" and an "incidental feature"?
A: The State Health Plan's direct benefits are the medical services covered (hospital, physician, prescription drug). The pre-tax payroll deduction mechanism in G.S. 135-40(c)-(d) is an incidental administrative feature, not a direct benefit. The AG drew this distinction to keep the duplication prohibition focused on the substance of coverage rather than expanding it to swallow all pre-tax-payroll-deduction tools.

Q: Did this opinion authorize HSAs?
A: No, HSAs as we know them today are a creation of the Medicare Modernization Act of 2003. In 1995 the question was about FSAs and similar pre-tax cafeteria-plan instruments. The opinion's logic does carry forward to HSAs, but anyone designing an HSA program today is working under a different and more developed federal framework.

Background and statutory framework

The Teachers' and State Employees' Retirement System (TSERS), the State Health Plan, and the Disability Income Plan are the three core state-employee benefit programs, governed by Articles 1, 3, and 6 of Chapter 135 of the NC General Statutes. Each is funded by employer contributions, employee contributions, or both, and each provides a defined set of benefits (a pension benefit under TSERS, medical coverage under the State Health Plan, income replacement under DIP). The General Assembly built these around the principle of uniform, mandatory baseline benefits for state employees, with limited employee choice over level of coverage.

Optional employee-choice benefits, including pre-tax payroll deduction for items like dental coverage, vision coverage, and medical spending accounts, were authorized in the mid-1990s through the NC Flex framework. G.S. 116-17.2 (for UNC) and G.S. 143-34.1(d) (for the executive branch generally) carved out a space for these optional benefits while expressly excluding any program that would duplicate the three baseline plans. Executive Order 66 implemented the framework.

The structural design (mandatory baseline + optional extras) is a common public-employer benefits architecture. The 1995 opinion is an early implementation-stage clarification: yes, the optional layer can include an MSA, because an MSA fills coverage gaps in the mandatory baseline rather than duplicating it.

Citations

• N.C.G.S. § 116-17.2 (UNC NC Flex authority and duplication prohibition)
• N.C.G.S. § 135-39.5B (alternative prepaid hospital/medical plans approved by Major Medical Plan board)
• N.C.G.S. § 135-40 (State Health Plan provisions)
• N.C.G.S. § 135-40(c), (d) (pre-tax payroll deduction for State Health Plan premiums)
• N.C.G.S. § 143-34.1(d) (executive branch NC Flex authority and duplication prohibition)
• Article 1A of Chapter 120 (Legislative Retirement System)
• Articles 1, 3, 6 of Chapter 135 (TSERS, State Health Plan, DIP)
• Executive Order No. 66 (establishing NC Flex)

Source

• Landing page: https://ncdoj.gov/opinions/medical-spending-account-on-a-pre-tax-basis-in-the-statewide-employee/

Original opinion text

November 3, 1995

Mr. Ronald G. Penny, Director
Office of State Personnel
116 West Jones Street
Raleigh, North Carolina 27603-8004

Re: Advisory Opinion to Ronald G. Penny, State Personnel Director, from the Office of the Attorney General, Administrative Division, Service to State Agency Section, Concerning the Application of Certain Prohibitions Contained in N.C. Gen. Stat. §§ 116-17.2 and 143-34.1(d) to the Proposal to Include A Medical Spending Account on a Pre-Tax Basis in the Statewide Employee Flexible Benefits Program Created by Executive Order No. 66.

Dear Mr. Penny:

We are writing in response to your letter of October 3, 1995, to Attorney General Michael F. Easley. In that letter, you noted that a question had recently been raised as to whether the new Statewide Employee Flexible Benefits Program ("NC Flex"), established by Executive Order 66, could offer certain benefit options under present statutory provisions. Specifically, you stated that Coopers and Lybrand, in their "Study of Flexible Benefits Plans for State Employees," questioned whether NC Flex could offer a medical spending account without violating N.C. Gen. Stat. § 135-40. You further stated that Coopers and Lybrand's concern was based on the directives of N.C. Gen. Stat. §§ 116-17.2 and 143-34.1(d), which authorize NC Flex and which expressly exclude from coverage under the flexible benefits plan "those benefits provided to employees [and officers] under [Article 1A of Chapter 120 of the General Statutes, and] Articles 1, 3, and 6 of Chapter 135 of the General Statutes." [The provisions in brackets are contained in N.C. Gen. Stat. § 143-34.1(d) only.] You asked for an opinion whether the inclusion on a pre-tax basis of a medical spending account in NC Flex will violate the prohibitions contained in these two statutes.

The quoted provisions of N.C. Gen. Stat. §§ 116-17.2 and 143-34.1(d) prohibit NC Flex from duplicating the benefits provided by the Legislative Retirement System of North Carolina, the Teachers' and State Employees' Retirement System of North Carolina, the Teachers' and State Employees' Comprehensive Major Medical Plan, and the Disability Income Plan of North Carolina. The reason for this prohibition is readily apparent: each of these plans is designed to provide basic benefits of uniform design to the employees covered by it. Moreover, participation in each of the plans is mandatory (except to the extent that N.C. Gen. Stat. § 135-39.5B allows for employees to enroll in an alternative prepaid hospital and medical benefit plan approved by the Executive Administrator and Board of Trustees of the Major Medical Plan in consultation with the Committee on Employee Hospital and Medical Benefits). Additionally, each of these plans is funded, in whole or in part, by employer contributions made by the State of North Carolina, through its various departments and agencies. It is certainly in the State's best interest not to have optional employee benefit plans that duplicate or compete with the benefits offered by these plans. Nor is it in the best interests of employees to contribute to flexible compensation and benefit options that merely duplicate the benefits they already receive from the State-sponsored plans.

The question remains, then, whether the medical spending account that is planned for inclusion in NC Flex will duplicate the benefits offered by Chapter 135, Article 3, of the North Carolina General Statutes. In our opinion, it will not. As the medical spending account has been described by you, by Coopers and Lybrand, and, in a separate request for an opinion on this subject from Evelyn Terry (counsel to the Teachers' and State Employees' Comprehensive Major Medical Plan), the medical spending account to be included in NC Flex will provide benefits over and above rather than duplicate those benefits provided under Chapter 135, Article 3, of the General Statutes. It will do this by filling in gaps in coverage and by reimbursing the employee for out-of-pocket expenses, including deductibles, co-insurance, and co-payments. This being so, inclusion of the a medical spending account in NC Flex will not, in our opinion, violate the prohibitions contained in N.C. Gen. Stat. §§ 116-17.2 and 143-34.1(d).

We would note also that our understanding of Cooper and Lybrand's study is that their concern was not that the direct benefits offered by the medical spending account would duplicate medical benefits provided by Chapter 135, Article 1. Rather, it appears that their concern is that, in their opinion, N.C. Gen. Stat. § 135-40(c) and (d), which allow employee-paid premiums to be paid through payroll deduction on a pre-tax basis, may prohibit NC Flex from offering any other medical benefits on a pre-tax basis. We do not believe, however, that this is a correct interpretation of N.C. Gen. Stat. § 116-17.2 and 143-34.1(d) or of N.C. Gen. Stat. § 135-40(c) and (d). The prohibition against duplication of benefits contained in N.C. Gen. Stat. § 116-17.2 and 143-34.1(d) applies, we believe, only to the actual, direct benefits provided in the specified Articles. Payment of premiums through payroll deduction on a pre-tax basis is an incidental benefit allowed by N.C. Gen. Stat. § 135-40; it is not an actual, direct benefit provided by the Teachers' and State Employees' Comprehensive Major Medical Plan. Accordingly, we do not believe that N.C. Gen. Stat. § 116-17.2 and 143-34.1(d), when read in conjunction with N.C. Gen. Stat. § 135-40(c) and (d), in any way prevent NC Flex from providing a medical spending account on a payroll deduction, pre-tax basis.

We trust that this fully answers your questions on this matter. Please do not hesitate to contact us if we can be of any further assistance.

Ann Reed
Senior Deputy Attorney General

Alexander McC. Peters
Special Deputy Attorney General