In the case of health FSAs, the COBRA requirements apply as follows.
Qualifying event plan year. The FSA need not make COBRA available to a qualified beneficiary if the following condition is met: As of the date of the qualifying event, the maximum benefit available to the qualified beneficiary under the health FSA for the remainder of the plan year is not more than the maximum amount that the plan could require as payment for the remainder of that year to maintain coverage under the health FSA.
For example, Mr. Brown terminates employment on July 1, 2011, at which time he has already claimed $600 of a possible $1,200 from his 2011 health FSA. Because it would cost Mr. Brown $612 ($600 plus the 2-percent administrative fee) to obtain the maximum benefit available for the remainder of the year ($600), COBRA coverage for the health FSA does not have to be offered to Mr. Brown for 2011 or subsequent years. However, if at Mr. Brown's termination date, he had more than $612 available for reimbursement from the FSA, COBRA would have to be extended for the FSA for the balance of the year only (not for subsequent years) because Mr. Brown's $612 cost is less than the maximum benefit he could gain.
However, to avoid having to determine the maximum benefit available for each qualified beneficiary for the remainder of the plan year, the administrator of the health FSA may make COBRA continuation coverage available to every qualified beneficiary in the year of the beneficiary's qualifying event.
Subsequent plan years. COBRA continuation coverage need not be extended to a qualified beneficiary for any plan year after the plan year in which the qualifying event occurs if the health FSA satisfies the following two conditions:
1. It is not subject to the HIPAA portability provisions because the benefits provided under the health FSA are HIPAA-excepted benefits. A health FSA is exempt from HIPAA when the employer also provides another group health plan, the benefits under that group health plan are not limited to HIPAA-excepted benefits, and the maximum reimbursement under the health FSA is not greater than two times the employee's salary reduction election (or, if greater, the employee's salary reduction election plus $500); and
2. In the plan year in which the qualifying event occurs, the maximum amount that the health FSA could require to be paid for a full plan year of COBRA equals or exceeds the maximum benefit available under the health FSA for the year.
For example, an employer sponsors a group health plan and a health FSA to cover unreimbursed medical expenses. The maximum benefit the health FSA provides for the year is the amount that the employee elects to deduct pretax from his paycheck (e.g., $1,200), but the COBRA cost for the FSA coverage would be $1,224 (the maximum benefit amount plus the 2-percent COBRA administration fee). In this case, the health FSA is not subject to COBRA in plan years subsequent to the year in which the qualifying event occurs.
Source: IRS Final Reg. §54.4980B-2, Q&A-8.