Cafeteria Plans

Need to do more research? Try this website
http://www.dol.gov/ebsa/pdf/rdguide.pdf
http://www.dol.gov/compliance/

What is a cafeteria plan?

A cafeteria plan is a separate written plan maintained by an employer for employees that meets the specific requirements of and regulations of section 125 of the Internal Revenue Code. It provides participants an opportunity to receive certain benefits on a pretax basis. Participants in a cafeteria plan must be permitted to choose among at least one taxable benefit (such as cash, salary reduction, payment for annual leave, sick leave or paid time off, severance pay, property, and certain after tax employee contributions) and one qualified benefit.  The new health reform law of 2010 said a small employers (an employer who during the 2 preceding years employed an average of 100 or fewer employees) qualifies for a SIMPLE cafeteria plan (no need to satisfy nondiscrimination requirements). If a company qualifies for a Simple Cafeteria Plan, it must follow the following rules:
1. Contribute  qualified benefits equal to a uniform percentage (not less than 2%) of the employees compensation for the
    year  or
2. Twice the amount of the salary reduction contributions of each qualified employee.
3. All employees  who had at least 1,000 hours of service for the preceding plan year are eligible to participate, and all
   employees have the same election rights under the plan. An employer can elect to exclude employees under age 21<
  who have less than one year of service, or who are covered under a collective bargaining agreement.

THE PLAN:
The written plan must specifically describe all benefits and establish rules for eligibility and elections.

A qualified benefit is a benefit that does not defer compensation and is excludable from an employee’s gross income under a specific provision of the Code, without being subject to the principles of constructive receipt.

Qualified benefits include:

Accident and health benefits (but not Archer medical savings accounts or long-term care insurance);
Adoption assistance;
Dependent care assistance- An employee can generally exclude from gross income up to $5,000 of benefits received under a
                                          dependent  care assistance program each year.  (MFS $2500). The exclusion cannot be more than the
                                          earned income of  either the employee or the employee’s spouse
Group-term life insurance coverage;
Health savings accounts, including distributions to pay long-term care services.
A flexible spending arrangement (FSA) is a form of cafeteria plan benefit and come in 3 types (Dependent care assistance, adoption assistance, medical care reimbursement) The maximum amount of reimbursement from a health FSA must be available at all times during the period of coverage. In other words if an employee differs $2000 for the plan year, and submits expenses of $2000 on Jan 15th the employer would reimburse it even though only a small portion has yet to been withheld from the employees paycheck.
All medical expenses must be substantiated before expenses are reimbursed under a  health FSA. A cafeteria plan can limit enrollment in a health FSA to those employees who participate in the employer's health insurance plan. 

A section 125 plan is the only means by which an employer can offer employees a choice between taxable and nontaxable benefits without the choice causing the benefits to become taxable. A plan offering only a choice between taxable benefits is not a section 125 plan.

Nonqualified benefits:
A cafeteria plan must not offer any of the following benefits:
Scholarships
Employer provided meals & lodging
Educational assistance
Fringe benefits
Group term life for an employee's spouse ,child or dependent 
Long-term care insurance, long-term care services. (An Health Savings Account -HSA  funded through a cafeteria plan
       may  be used to pay for premiums for long-term care services)
A cafeteria plan may not offer a Health flex spending account that permits carryover of unused benefits.
 

TAX BENEFITS:
Generally, qualified benefits under a cafeteria plan are not subject to FICA, FUTA, Medicare tax, or income tax withholding. However, group-term life insurance that exceeds $50,000 of coverage is subject to social security and Medicare taxes, but not FUTA tax or income tax withholding, even when provided as a qualified benefit in a cafeteria plan. Adoption assistance benefits provided in a cafeteria plan are subject to social security, Medicare, and FUTA taxes, but not income tax withholding. If an employee elects to receive cash instead of any qualified benefit, it is treated as wages subject to all employment taxes. For more information, see Publication 535, Chapter 5 or Publication 15-A .

HOW IT WORKS:
Employer contributions to the cafeteria plan are usually made pursuant to salary reduction agreements between the employer and the employee in which the employee agrees to contribute a portion of his or her salary on a pre-tax basis to pay for the qualified benefits. Salary reduction contributions are not actually or constructively received by the participant. Therefore, those contributions are not considered wages for federal income tax purposes. In addition, those sums generally are not subject to FICA and FUTA. See Sections 3121(a)(5)(G) and 3306(b)(5)(G) of the Internal Revenue Code.

A Flexible spending benefit (FSA) is where the Employee is reimbursed for expenses incurred for certain qualified benefits. An FSA may be offered for dependent care assistance, adoption assistance, and medical care reimbursements. The benefits are subject to an annual maximum and are subject to an annual “use-or-lose” rule. An FSA cannot provide a cumulative benefit to the employee beyond the plan year.  Forfeited contributions are called Experience gains and can be retained by the employer sponsoring the cafeteria plan, or use forfeitures to defray expenses of administering the plan, or allocate forfeitures among employees contributing through salary reduction on a  reasonable an uniform basis.

ITS IMPORTANT TO FOLLOW THE RULES:
The consequence can lead to adverse tax implications

The plan is not a cafeteria plan if, due to the following actions, it fails to satisfy the requirements of Sec. 125 and the regulations, due to the following:

Offering nonqualified benefits See list of qualified benefits above)
You must offer an election between at least one permitted taxable benefit and at least one qualified benefit
Deferring compensation is NOT a benefit and will disqualify the plan. Benefits may not be carried over to a later plan year
     or used in one plan year to purchase benefits in a later plan year (example: Life insurance that has a cash value build
     up or group term life insurance with a permanent benefit)
      Proposed regulations provide that the following DO NOT Count as deferred compensation practices:
     - long term disability policy
     - paying benefits over more than one plan year,
     - reasonable policy dividends,
     - certain 2-yr lock in vision and dental  policies
     - certain advance payments for orthodontia
     - salary reduction contributions in last month of a plan year used to pay health premiums for 1st month of following plan
         year.
Failing to comply with the uniform coverage rule or use-it-or-lose-it rule will disqualify the plan.
Allowing employees to revoke elections or make new elections during a plan year, except as provided in the rules.
Failing to comply with substantiation requirements.
Paying or reimbursing expenses incurred for qualified benefits before the effective date of the cafeteria plan or before a period of coverage.
Allocating experience gains (forfeitures) other than as expressly allowed in the new proposed regulations; and
failing to comply with grace period rules
 

IT IS IMPORTANT TO HAVE A WRITTEN PLAN- Click here to receive a plan that meets requirements and to purchase software to track the plan benefits!  SAVE BIG!

Proposed regs to include the following so if you are designing a plan, keep these key points in mind:

A specific description of each of the benefits available through the plan, including the periods during which the benefits are provided.

The rule that all participants in the plan are employees (including common law employees, leased employees (section 414) and full-time life insurance salesmen (section 7701(a)(20). Former employees including laid-off and retired may participate, but a plan may not be maintained predominantly for former employees..

Procedures for what can be elected by the employees under the plan.
The  period when elections can be  made.
The effective dates with respect to the elections
A disclosure that elections ARE IRREVOCABLE
     except to the extent that the optional change in status rules in Reg. Sec. 1.125-4 are included in the cafeteria plan.

What is the  manner of employer contributions -.through an employee’s salary reduction election or by non-elective
      employer contributions.

What is the maximum amount of employer contributions available to any employee through the plan, by stating
(A) the maximum amount of salary reduction available to any employee through the plan, expressed as a maximum dollar amount or a maximum percentage of compensation; and
(B) for contributions to 401(k) plans, the maximum amount of elective contributions available to any employee through the plan, expressed as a maximum dollar amount or maximum percentage of compensation that may be contributed as elective contributions through the plan by employees; Although a cafeteria plan generally cannot include any plan or option that provides for deferred compensation, this restriction does not apply to 401(k) plans. Thus, elective deferrals and
after-tax contributions may be made to a separate 401(k) plan through a cafeteria plan. The rules on change-in-family-status changes under a cafeteria plan cannot be applied to 401(k) plan contributions, and elective deferrals to a 401(k) plan should not be included in the benefits amounts that are tested under the Section 125 nondiscrimination test

What is the plan year of the cafeteria plan.

If the plan offers paid time off, the required ordering rule for use of non-elective and elective paid time off;

If the plan includes FSAs (as defined in Reg. Sec.1.125-5(a)), the plan’s provisions complying with any additional requirements for those FSAs;

If the plan includes a grace period, the plan’s provisions complying with the grace period rules; and

If the plan includes distributions from a health care flexible spending account to employees’ Health Savings Account (HSAs), the plan’s provisions complying with the applicable rules.

Section 125- frequently asked questions

GROUP TERM LIFE COVERAGE:
The proposed regulations provide that the entire amount of salary reduction and employer flex credits for group-term life insurance coverage on the life of an employee is excludable from an employee’s gross income.

The new proposed regulations differ from Notice 89-110 (C.B. 1989-2 447), which provides that an employee includes in gross income the greater of the Table I cost of group term life insurance coverage exceeding $50,000 or the employee’s salary reduction and employer flex credits for excess group term life insurance coverage. The new proposed regulations provide instead that the employee includes in gross income the Table 1 cost of the excess coverage (minus all after-tax contributions by the employee for group term life insurance coverage) and that the entire amount of salary reduction and employer flex credits for group term life insurance coverage on the life of the employee is excludable from the employee’s gross income.

Proposed changes to INDIVIDUAL PREMIUMS.
The new proposed regulations specifically permit a cafeteria plan (but not a health care Flexible Spending Account) to pay or reimburse substantiated individual accident and health insurance premiums. In addition, a cafeteria plan may provide for payment of COBRA premiums for an employee.

Proposed changes to PLAN YEAR:  The new proposed regulations require that a cafeteria plan year be 12 consecutive months and be set out in the written cafeteria plan. A short plan year (or a change in plan year resulting in a short plan year) is permitted only for a valid business purpose. A change in plan year resulting in a short plan year, for other than a valid business purpose, is disregarded. If a principal purpose of a change in plan year is to circumvent the rules of Sec. 125, the change in plan year is ineffective.

Proposed Regs allow a GRACE Period
The proposal allows a written plan to provide an optional grace period immediately following the end of the plan year, extending the period for incurring expenses for qualified benefits (health FSA or dependent care assistance), but in
no event does it apply to paid time off or contributions to a 401K. Unused benefits or contributions for one qualified
benefit may only be used to reimburse expenses incurred during the grace period for the same qualified benefit. The amount of unused benefits and contributions available during the grace period may be limited by the employer. The grace period may extend to the 15th day of the 3rd month after the end of the plan year (or for a shorter period). Benefits or contributions not used are forfeited under the use-or-lose rule.

Nondiscrimination Rules. Discriminatory benefits provided to highly compensated participants and individuals and key employees are included in these employees' gross income.  The new proposed regulations define highly compensated individual or participant consistent with the IRC Sec. 414(q) definition of highly compensated employee.
These regulations provide an objective discrimination test to determine when the actual election of benefits is discriminatory. Specifically, these regulations provide that a cafeteria plan must give each similarly-situated participant a uniform opportunity to elect qualified benefits, and that highly compensated participants must not actually disproportionately elect qualified benefits.

NEW BEGINNING IN 2011
The new health reform law of 2010 said a small employers (an employer who during the 2 preceding years employed an average of 100 or fewer employees) qualifies for a SIMPLE cafeteria plan (no need to satisfy nondiscrimination requirements). If a company qualifies for a Simple Cafeteria Plan, it must follow the following rules:
1. Contribute  qualified benefits equal to a uniform percentage (not less than 2%) of the employees compensation for the
    year  or
2. Twice the amount of the salary reduction contributions of each qualified employee.
3. All employees  who had at least 1,000 hours of service for the preceding plan year are eligible to participate, and all
   employees have the same election rights under the plan. An employer can elect to exclude employees under age 21<
  who have less than one year of service, or who are covered under a collective bargaining agreement.

Proposed effective date It is proposed that these proposed regulations apply for plan years beginning on or after 1/01/2009. Taxpayers may rely on these regulations for guidance pending the issuance of final regulations.

Go ahead!!! Save both your company and your employees money! We recommend visiting and utilizing the services and software from Flex spending site as  they make it easy to do it yourself and still stay in compliance!