If your company offers health insurance, it's likely that your employees have the option of paying their share of the premiums through a reduction in their paychecks. You may not know it, but your employees' premium contributions are allowed to be deducted pre-tax because of a vehicle known as the "cafeteria plan." While this type of arrangement is very common, it is also a source of much confusion for employers. Here are five frequently asked questions and answers to break down the basics.
1. What is a cafeteria plan?
A cafeteria plan is an employee benefit plan that permits employees to choose between receiving cash (the employee's normal wages) and certain qualified benefits (such as health insurance) that can be paid for on a pre-tax basis by employees.
Contributions to a cafeteria plan are usually made through a salary reduction agreement, in which the employee elects to reduce his or her compensation by a stated amount on a pre-tax basis to pay for the qualified benefits. Salary reduction contributions are not actually received by the employee, so they are not considered wages for federal income tax purposes and generally are not subject to FICA (Social Security and Medicare) or FUTA (federal unemployment) taxes, although certain exceptions do apply.
2. Can a small company offer a cafeteria plan?
Yes—what matters is whether your company wants to offer employees certain benefits on a pre-tax basis. There is no minimum size required for a company to sponsor a cafeteria plan. However, note that certain individuals are not considered "employees" for purposes of a cafeteria plan, including self-employed persons and shareholders in an "S" corporation who hold more than 2% of the stock.
3. Are there different kinds of cafeteria plans?
Yes. One of the simplest plans is a "premium-only-plan" (POP), which allows for pre-tax health insurance premium contributions by employees. Under a POP plan, the sole benefit is allowing employees to pay their share of employer-provided health insurance premiums with pre-tax dollars, thereby excluding the amount of the employee's contributions from his or her gross income (and lowering the employee's tax liability).
A flexible spending arrangement (FSA) is another form of cafeteria plan benefit, funded by an employee's voluntary salary reduction, that allows the employee to seek reimbursement for permitted expenses incurred for certain qualified benefits like medical care or dependent care assistance.
Finally, there is the cafeteria plan that allows a selection from among various benefits and even various levels of the same benefit, e.g., a lower or higher cost medical plan.
4. Who may receive benefits under a cafeteria plan?
A cafeteria plan may make benefits available to employees, their spouses and dependents. It may also include coverage of former employees, but cannot exist primarily for them.
5. What benefits can be included in a cafeteria plan?
Certain "qualified benefits" may be offered in a cafeteria plan. A "qualified benefit" is a benefit which is not includible in an employee's gross income under the Internal Revenue Code and which does not defer the receipt of compensation (a cafeteria plan can, however, include a qualified 401(k) plan as a benefit).
Qualified benefits for a cafeteria plan generally include:
- Accident and health benefits (but not Archer medical savings accounts or long-term care insurance);
- Health savings accounts (HSAs);
- Group-term life insurance coverage; and
- Dependent care and adoption assistance.
Benefits that cannot be included in a cafeteria plan include de minimis benefits, educational assistance, transportation (commuting) benefits, tuition reduction, and working condition benefits.
Please Note: Cafeteria plans must meet the specific requirements and regulations of Section 125 of the Internal Revenue Code, which requires, among other things, the development of a written plan describing the benefits and establishing rules for eligibility and elections. The plan must also satisfy various tests for nondiscrimination with respect to certain highly compensated and key employees.
If you have any questions regarding whether your plan is a cafeteria plan or whether it complies with the law, please consult with a knowledgeable benefits attorney or specialist. For more information on cafeteria plans generally, including changes as a result of Health Care Reform, visit our section on Cafeteria Plans. And to review other Health Care Reform requirements that may affect your company this year, be sure to download our Health Care Reform Compliance Checklist for 2012.
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