With apologies to Paul Simon, cafeteria plans arent still crazy, but they are still going strong after all these years.
Cafeteria plans are governed under Section 125 of Internal Revenue Code as part of the Revenue Act of 1978, the same legislation that added Section 401(k). The idea was simple: allow employees to re-direct their otherwise taxable compensation to benefits which would be received on a pre-tax basis.
Section 125, like Section 401(k), has been amended from time but has largely been flying under the radar since 1978. But unlike 401(k) plans, cafeteria plans are not subject to FICA taxes for both the employee and the employer.
With the passage of the Affordable Care Act, cafeteria plans have been rediscovered by a whole new generation of employers and their advisers.
There can be four kinds of benefits provided through a cafeteria plan: 1) premium only plan, 2) flexible spending account, 3) dependent care benefit, and 4) adoption assistance benefit. Here, in the most basic terms, is what advisers need to know about these cafeteria plans.
1. Premium only plan
The POP part of a cafeteria plan allows employees to pay for certain group insurance coverage on a pre-tax basis. Coverage may include dental, vision, disability and term life insurance. Many employers dont go beyond the POP.
2. Flexible spending account
This part of the cafeteria plan is governed by Section 105 and 106 of the IRS code, and provides for special accounts that allow employees to use pre-tax dollars to pay out-of-pocket medical expenses not covered by health insurance. An employee can defer up to $2,500 maximum in 2014. Eligible medical expenses are those that count toward the medical expenses deduction listed in Internal Revenue Service
3. Dependent care benefit
This part of the cafeteria plan is governed by Section 132 and allows employees to be reimbursed for child and adult daycare expenses on a pre-tax basis. Employees can be reimbursed up to $5,000 in 2014 for married couples, or up to $2,500 if the employee is married, filing separately. However, it may be more advantageous for the employee to take the Dependent Care Tax Credit.
4. Adoption assistance benefit
This part of the cafeteria plan is governed by Section 137 and permits employees to be reimbursed for qualified adoption expenses on a pre-tax basis. However, this benefit, unlike the other three, is subject to FICA taxes. In 2014, the limit is $13,190.
How a cafeteria plan works
Cafeteria plans, like all benefit programs, need to be administered. Some employers self-administer their programs, and others outsource administration to a service provider. Regardless of the method used, there are some important matters common to each.
First, the dollar limits mentioned above are subject to annual cost of living adjustments by the IRS except of adoption benefits.
Second, cafeteria benefits must be available to the employee during the year regardless of the amount withheld. For example, if an employee elects to have $1,200 withheld during the year ($100 per month) and incurs $1,200 of eligible expenses in March, the entire amount must be reimbursed.
Third, they have a use it or lose it rule under which benefits not used during the year are lost subject to a two-and-a-half month grace period. The IRS modified that rule so that effective Jan. 1, 2014, employees can carry over up to $500.
Fourth, cafeteria plans are ERISA plans and subject to non-discrimination rules similar to, but different, than 401(k) plans.
Fifth, as an ERISA plan, cafeteria plans, must file Form 5500 unless exempted. Most small employers qualify for the exemptions.
Finally, as noted above, cafeteria plan benefits, with the exception of adoption benefits, are not subject to FICA benefits. Thus, the employee may receive slightly lower Social Security benefit which must be communicated to the employees.
This discussion about Cafeteria Plan is necessarily brief and should not be considered tax or legal advice. Cafeteria Plans are not a fit for all employers. They should review their particular facts and circumstances particularly in the context of the Affordable Care Act with their tax and benefit advisors.
Kalish is an EBA Advisory Board member and president of National Benefit Services Inc., a Chicago-based third party administrator. He is a guest lecturer at John Marshall School of Law LLM Program in Employee Benefits and Services on the Great Lakes IRS Advisory Council for Tax Exempt and Government Entity Plans. Kalish has been publishing
