For this reason, it is wise to be conservative when estimating the amount of money needed for medical expenses. Likewise, it is very difficult to change the withholding during the year. Unless certain life events are present, such as divorce or death in the family, most employees must wait until the end of the year to address a decrease or increase in the contribution. If a cafeteria plan violates the special rules of Section 125, a benefit that may be tax-exempt if offered outside a cafeteria plan could lose its tax exemption if it is offered inside the plan. For example, an employee with a working spouse may choose to opt out of the health insurance plan if the spouse has a better health plan. The extra cash that then becomes available may be used to establish a reimbursement account for uninsured health expenses or childcare costs.
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 and one qualified benefit. On Aug. 6, 2007, the IRS issued proposed regulations governing Section 125 plans Ñ aka cafeteria plans Ñ reflecting several changes occurring since 1997, as well as incorporating new guidance. A cafeteria plan is a plan named for Section 125 of the Internal Revenue Code and allows an employee to elect a non-taxable benefit (e.g., medical coverage) in lieu of a taxable benefit .
Employers save payroll taxes on employee contributions, too. An FSA has to meet all the complex nondiscrimination requirements for cafeteria plans. It also requires an employee to evaluate their personal and family benefit situations and file an election form every year to estimate their benefit needs. An FSA can provide tax benefits for employees that are usually not available from other plans.
In order to use a pre-tax benefit plan, it must be offered by the employer. Self-employed people are not eligible to participate, nor are non-employee directors. Sole proprietors of businesses cannot be a part of a plan, but they can sponsor them for their employees. If a person would like to be involved in a plan, but it is not offered by their employer, the topic should be addressed. Employers must spend some time on the plan, but it can prove to be a tax savings to them as well as the employee. The IRS allows employers to set up these plans for their employees as a means of setting aside money for specific life events on a pre-tax basis.
Plans should consider which change in status events to allow, how to track change in status requests, and the time limit to impose on employees who wish to make an election. Plans are permitted to make automatic payroll election increases or decreases for insignificant amounts in the middle of the plan year, so long as automatic election language is in the plan documents. An “insignificant” amount is considered one percent or less. Most companies find that the use of a third-party administrator is the simplest route to use when setting up a Section 125 plan. The outsourced agency can handle the daily administration requirements while the internal human resources team can help workers understand the benefits of each offer.
They are vital for those with dependents or long-term health problems, but are also a nice savings for those medical events that happen without warning. A cafeteria plan is an excellent, no-fuss savings for expenses that are faced by everyone during the year. Also, employers don’t have to pay these payroll taxes on their employees’ pre-tax contributions through a cafeteria plan. Employers also don’t have to pay payroll taxes on their own contributions to employees’ HSAs.
As an added advantage, employees receive an effective raise without any additional cost to the employer. Since more participants in the plan equate to more tax savings for the employer, it is often suggested that the employer contributes to each employee’s plan to promote increased participation by those not yet in the Section 125 plan. Employees must estimate how much money they are going to contribute to their cafeteria plan before the tax year begins.
An FSA cannot provide a cumulative benefit to the employee beyond the plan year. A “Cafeteria Plan” is a benefit provided by an employer which allows an employee to contribute a certain amount of his or her gross income to a designated “account” before taxes are calculated. This “account” can be used to reimburse the employee for insurance premiums, medical, or dependent care expenses throughout the plan year or claim period as the employee incurs qualified expenses.
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. But there are drawbacks to cafeteria plans, especially if the employee chooses a taxable benefit such as cash. In cases like these, the employee will incur a tax liability for the tax year on the amount of the cash benefit received. However, not all benefits are available as pretax benefits. In every case, fringe benefits are to be included as income to the employee, unless section 125 specifically excludes it and allows it to be provided to employees pretax. Examples of benefits that can’t be offered pretax are employee discounts, moving expenses, retirement planning, commuter benefits, education assistance, and tuition reimbursement.
POP is another kind of tax-free vehicle offered under IRS section 125 that has fewer compliance requirements than a traditional larger employer cafeteria plan. A cafeteria plan has to include at least one taxable benefit option to be compliant with section 125 of the tax code. The government views the taxable option as part of the employee’s salary. An example of a taxable option would be allowing employees to take the monthly amount as cash into their salary instead of using it toward the benefit plan. They could also use the money to purchase benefits that aren’t tax-free like a gym membership.
Even if money doesn’t go toward a retirement plan, employees can have more discretionary spending funds to use for a variety of needs. It is easier to establish an emergency savings plan with the freed-up cash from a cafeteria plan than it is to use a more traditional benefits package. When workers have an opportunity to use a flexible savings account, then there are opportunities to save money on everyday expenses. That means more cash gets freed up to be allocated to other needs, including a 401 or 403 account. Most companies find that the offering of a cafeteria plan increases the participation rates in the retirement benefits being provided. The IRS outlines the legal requirements for these plans under Section 125 of the Internal Revenue Code.
100–647 effective, except as otherwise provided, as if included in the provision of the Tax Reform Act of 1986, Pub. 99–514, to which such amendment relates, see section 1019 of Pub. 101–239 effective, except as otherwise provided, as if included in the provision of the Technical and Miscellaneous Revenue Act of 1988, Pub. 100–647, to which such amendment relates, see section 7817 of Pub. 98–612, made identical amendments, substituting cross reference provision for reporting requirements provisions. 100–647, § 1018, inserted “or rural electric cooperative plan (within the meaning of section 401)” after “stock bonus plan”, see Codification note above. 111–148, § 1515, , substituted “For purposes of this section—” for “For purposes of this section,”; designated remainder of first sentence and second sentence as par.
Thus, a cafeteria plan may permit an employee to modify or revoke elections in accordance with section 401 and and the regulations thereunder. The cafeteria plan permits participants to make an election for a period of coverage that is different from the period of coverage under the other cafeteria plan or qualified benefits plan. or Medicaid loses eligibility for such coverage, the cafeteria plan may permit the employee to make a prospective election to commence or increase coverage of that employee, spouse, or dependent under the accident or health plan.
A cafeteria plan is just a fancy term for a certain way to group the employee benefits you get at work, like health insurance. It’s important because if you’re paying for any of the benefits, a cafeteria plan is a way to pay for them with pre-tax income, which is not federally taxed. A cafeteria plan is a type of employee benefit plan offered in the United States pursuant to Section 125 of the Internal Revenue Code. Its name comes from the earliest such plans that allowed employees to choose between different types of benefits, similar to the ability of a customer to choose among available items in a cafeteria.
The simplest contribution tool is a flat percentage of wages allowing employees to pick the benefit that best serves them and their family. SARSEP – Southern elects to make a 4% contribution to the plan across the board for all employees. Beverly elects to contribute $100 per month as a part of the salary reduction element of the plan. HDHP – Southern selected a health plan that carries a $4,000 deductible and $9,000 deductible . Generally, members of LLCs or LLPs are treated as partners for tax purposes and, as such, are also not allowed to participate in the cafeteria plan. No regulations exclude shareholders of any percentage in a “C-Corp” from participating in a cafeteria plan.
The views expressed on this blog are those of the blog authors, and not necessarily those of ADP. This blog does not provide legal, financial, accounting, or tax advice. The content on this blog is “as is” and carries no warranties. ADP does not warrant or guarantee the accuracy, reliability, and completeness of the content on this blog. Employers can adopt a two-and-a-half month grace period after the end of the plan year for FSAs to continue incurring expenses. ADP is a better way to work for you and your employees, so everyone can reach their full potential.
There are over 590 articles on this site about business tenets, principles and standards. During 2020, this site’s Value Investment Fund earned a 35.46% return. If you want to learn about value investing, click on the Value Investing tab in the header above. Businesses must distribute a summary plan description to everyone. Accounting Periods and Methods The following list of dual-purpose over-the-counter items can be reimbursed if used for medical purposes. They must be accompanied by a medical practitioner’s note stating the item is to treat a specific medical condition and not a cosmetic procedure. You need to provide either your email address or mobile phone number.
Is it current with the proposed changes and with the remainder of changes in the proposed regulations? Is it current with other federal laws such as HIPAA and the ACA? Discover a wealth of knowledge to help you tackle payroll, HR and benefits, and compliance. generally, substituting “and key bookkeeping employees” for “where plan is discriminatory” in heading and “Highly compensated participants” for “In general” in par. This subparagraph shall cease to apply if the employer employs an average of 200 or more employees on business days during any year preceding any such subsequent year.
While a Section 125 plan reduces the employee’s taxable income, it also may reduce other benefits. Benefits that are calculated using the employee’s income will, in turn, be reduced.
When reviewing the advantages and disadvantages of a cafeteria plan, it is essential to remember that it cannot discriminate in eligibility, contributions, or benefits. The IRS doesn’t consider self-employed individuals as employees, so they aren’t eligible for Cafeteria Plans. Also, LLC members, partners in a partnership, and 2% or greater owners of an S corporation are not allowed to make pre-tax HSA contributions through a cafeteria plan. C corporation owners are generally allowed to participate in cafeteria plans, however. For employers, having a cafeteria plan means they don’t have to follow IRS comparability rules. Under comparability rules, if employers contribute to their employees’ HSAs, they have to make comparable contributions to all other comparable participating employees’ HSAs. Reasons for implementing a Section 125 plan are primarily for the tax savings advantages for the employer and employee.
Both parties save on taxes and therefore increase their spendable income. Employees’ pretax contributions are not subject to federal, state, or social security taxes. Employers save on the employer portion of FICA, FUTA, and workers’ compensation insurance premiums. Certain non-qualified benefits that can’t be offered through a cafeteria plan include scholarships, educational assistance, fringe benefits, long-term care insurance and health reimbursement arrangements. The Health FSA is the traditional flex account that allows contributions of up to $2,650 per employee, on a pre-tax basis. For the employee, that’s like getting a 30% discount or health care products and services such as deductibles, co-pays, prescriptions, and many over-the-counter medical products without a prescription.
Author: Stephen L Nelson