Can NC Flex include a medical spending account where state employees set aside pre-tax dollars for out-of-pocket medical costs, without illegally duplicating the State Health Plan's coverage?
Plain-English summary
This is the companion to the November 3, 1995 opinion on supplemental life, AD&D, and disability insurance in NC Flex. The State Health Plan's general counsel, Evelyn B. Terry, asked whether NC Flex could include a "medical spending account" without violating the no-duplication rule in N.C.G.S. §§ 116-17.2 and 143-34.1(d) that prohibits NC Flex from duplicating benefits provided by the State's mandatory retirement, health, and disability plans.
Senior Deputy AG Ann Reed and Special Deputy AG Alexander McC. Peters answered yes.
The medical spending account in NC Flex. As described, the account allows state employees to set aside pre-tax salary dollars that they can later use to pay for out-of-pocket medical expenses not covered by the State Health Plan: deductibles, coinsurance, copays, and similar uncovered costs. The account is essentially a flexible spending account (FSA) in the Section 125 cafeteria-plan sense.
Why it does not duplicate the State Health Plan. The Comprehensive Major Medical Plan provides basic medical coverage. The medical spending account does not provide medical coverage; it reimburses the employee for out-of-pocket expenses that the basic coverage doesn't pay. The two layers are complementary, not competitive. An employee with both gets:
- State Health Plan: pays for covered medical services subject to deductibles, coinsurance, and copays.
- Medical Spending Account: reimburses the employee for those deductibles, coinsurance, and copays from the employee's pre-tax salary set-aside.
The substantive benefits (medical care vs. cash reimbursement of out-of-pocket costs) are different. The medical spending account fills a gap in coverage rather than providing duplicate coverage.
So the medical spending account does not violate the no-duplication rule. Executive Order No. 66's implementation including the spending account is consistent with §§ 116-17.2 and 143-34.1(d), not in conflict.
The Coopers & Lybrand pre-tax concern. Coopers & Lybrand, the consulting firm that studied flexible benefits for state employees, raised a separate concern. § 135-40(c) and (d) allow State Health Plan premiums to be paid through payroll deduction on a pre-tax basis. Coopers & Lybrand thought this might prohibit NC Flex from offering any other medical benefits on a pre-tax basis (because pre-tax payroll deduction would itself be a "benefit" of the State Health Plan that NC Flex would be duplicating).
The AG rejected that reading. The no-duplication rule applies to "actual, direct benefits provided in the specified Articles." Payment of premiums through pre-tax payroll deduction is an incidental administrative feature, not an actual direct benefit of the State Health Plan. So NC Flex is free to provide a medical spending account on a pre-tax basis without violating the rule.
Combined effect. State employees can:
- Maintain their mandatory State Health Plan coverage (basic medical).
- Pay their State Health Plan premiums through pre-tax payroll deduction under § 135-40.
- Set up an NC Flex medical spending account funded by additional pre-tax salary set-asides.
- Use the spending account to reimburse out-of-pocket medical costs.
This three-layer structure preserves the integrity of the State Health Plan while letting employees use pre-tax dollars for both premiums and out-of-pocket costs. It is the design pattern that most modern federal and state cafeteria plans use.
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 been substantially restructured since 1996. The State Health Plan has had major reforms, including the 2011 transition to a managed-care structure. The federal Affordable Care Act (2010) imposed new requirements on flexible spending accounts, including the $2,500 annual limit (now indexed for inflation). Anyone considering a medical spending account today should consult current state and federal law and current State Health Plan terms.
Background and statutory framework
Medical spending accounts are a form of cafeteria plan benefit governed by IRC § 125 and § 105(h) at the federal level. They let employees use pre-tax dollars to pay for medical expenses, including out-of-pocket costs not covered by their basic insurance. The pre-tax treatment gives employees an effective discount on those expenses equal to their marginal tax rate.
For state employees, the structure is particularly valuable because basic State Health Plan coverage typically has substantial out-of-pocket costs (deductibles, copays for prescription drugs, vision, dental, etc.). A medical spending account funded by $1,000-$2,500 per year of pre-tax salary can cover those costs with effective tax savings of 20-30%.
The no-duplication rule in NC's statutes was a structural protection against erosion of the State Health Plan's coverage and economic base. The AG's reading preserves that protection (the spending account does not compete with the basic plan) while allowing the cafeteria-plan benefits the legislature clearly authorized (the statutes themselves create the framework for a flexible benefits plan).
The pre-tax payroll deduction analysis is also analytically careful. § 135-40(c) and (d) does provide pre-tax treatment for State Health Plan premiums. But pre-tax treatment is a tax-administration feature, not a substantive benefit. The AG draws the right line: substantive benefit (basic medical coverage) is what the no-duplication rule protects; administrative pre-tax treatment is incidental and can be replicated by other plans.
The opinion is also a small but useful example of how AG offices interact with consulting firms hired by state agencies. Coopers & Lybrand's reading was overly cautious. The AG's reading was the right one and made the medical spending account viable. Without the AG's intervention, the spending account might have been blocked by a misreading of the no-duplication rule, depriving state employees of a valuable benefit.
Common questions
What expenses qualify for medical spending account reimbursement?
The opinion does not enumerate them, but standard FSA-eligible expenses (per IRC § 213(d) and IRS Publication 502) include deductibles, coinsurance, copays, prescription drugs, vision care, dental care, and certain over-the-counter medications (subject to changes by the Affordable Care Act). The State Health Plan and NC Flex administrators provide the specific list applicable to NC employees.
What is the use-it-or-lose-it rule?
Federal regulations require medical spending accounts to be used within the plan year (with limited grace periods or carryover allowed). Funds left in the account at year-end are forfeited. This is one of the key cost-management features of FSAs. Employees must estimate their annual out-of-pocket medical costs accurately when setting their contribution amount.
Could the State expand the spending account to cover other expenses (dependent care, transit, etc.)?
NC Flex did include dependent care assistance accounts in subsequent years, again on the cafeteria-plan model. The same no-duplication analysis would apply: as long as the additional account does not duplicate a benefit provided under Articles 1A of Chapter 120 or Articles 1, 3, or 6 of Chapter 135, it does not violate the statute.
What happens if an employee leaves state employment mid-year?
The opinion does not address termination scenarios. Federal cafeteria plan rules generally allow continued use of the spending account through the rest of the plan year if the employee has already contributed enough to cover the expenses, or termination of participation with COBRA-style continuation in some cases. The State Health Plan and NC Flex administrators handle the specific procedures.
Source
- Landing page: https://ncdoj.gov/opinions/application-of-certain-prohibitions-contained-in-%ef%bf%bd%ef%bf%bd-116-17-2-143-34-1d-2/
Citations
- N.C.G.S. § 116-17.2
- N.C.G.S. § 143-34.1(d)
- N.C.G.S. § 135-40(c) and (d)
- N.C.G.S. § 135-39.5B
- Article 3 of N.C.G.S. Chapter 135
- Executive Order No. 66
Original opinion text
November 3, 1995
Ms. Evelyn B. Terry
General Counsel
The North Carolina Teachers' and State Employees' Comprehensive Major Medical Plan
4509 Creedmoor Road, Suite 102
Raleigh, North Carolina 27612
Re: Advisory Opinion to Evelyn B. Terry, General Counsel, the North Carolina Teachers' and State Employees' Comprehensive Major Medical Plan, 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 Supplemental Life Insurance, Accidental Death and Dismemberment Insurance, and Supplemental Disability Insurance in the Statewide Flexible Benefits Program Created by Executive Order No. 66.
Dear Ms. Terry:
We are writing in response to your letter of October 10, 1995, to Attorney General Michael F. Easley. In that letter, you noted that, pursuant to Executive Order No. 66, the State of North Carolina is currently in the process of establishing a Statewide Flexible Benefits Plan, to be known as "NC Flex," for State employees. 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 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 as to whether Executive Order No. 66 overrides the provisions of N.C. Gen. Stat. §§ 116-17.2 and 143-34.1(d) such that inclusion of a medical spending account in NC Flex is allowable despite 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 Ronald G. Penny (Director of the Office of State Personnel), 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, coinsurance, and co-payments. Accordingly, 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). This being so, Executive Order No. 66 does not override the provisions of N.C. Gen. Stat. §§ 116-17.2 and 143-34.1(d) by providing for a medical spending account, but rather is consistent with those statutes.
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