Cafeteria plans allow employees to pay for certain “qualified benefits” on a pre-tax basis. Without a compliant written cafeteria plan, employees generally cannot pay for benefits on a pre-tax basis.
Cafeteria plans go by a variety of names (Section 125 plans, flexible benefit plans, etc.). They can also take a variety of forms. Some only allow for pre-tax insurance contributions (so-called, “POPs” or “PEO Alternative only plans”). Others include arrangements with flexible spending accounts (health and dependent care; each with applicable governing tax rules), pre-tax contributions to health savings accounts, or employer credits (often called “full-flex” plans).
If a cafeteria plan does not satisfy the tax rules, the employee must include in his or her gross income the value of the taxable benefit with the greatest value that the employee could have elected to receive. Usually, this is the amount of the employee’s payroll deductions.
Qualified benefits include:
Accidental death and dismemberment coverage
Short- and long-term disability coverage
Group term life insurance (up to $50,000 in coverage)
Health FSAs (to cover out-of-pocket medical expenses not covered by insurance)
Dependent care FSAs; and
Pre-tax health savings account (HSA) contributions.
Cafeteria Plan Requirements
Cafeteria plan elections must be made before the beginning of the plan year. Generally, they cannot be changed once the plan year starts. However, there are certain exceptions for IRS-defined “change in status” events. These events must be in the cafeteria plan document and in the underlying plan document for the applicable benefit. Additionally, HSA contributions can be changed at any time.
In addition, the plan must be established pursuant to a written plan document. The plan document must describe terms, election rules, and plan administration procedures. Note that some of the underlying benefits (such as health, dental, or vision coverage) must have separate plan documents under ERISA, which is a separate and different requirement.
The cafeteria plan must be adopted and effective on or before the first day of a plan year. Similarly, any amendments to the cafeteria plan can only be effective on or after they are adopted. The plan terms generally must be the same for all participants.
In addition, the IRS requires that the plan document contain the following information:
A description of all benefits and periods of coverage.
Eligibility and participation.
Election procedures (including specifying any IRS-sanctioned change in status events).
Employer contribution methodology.
The plan year.
Rules that apply to Flexible Spending Accounts (FSAs) (if applicable).
Rules that apply to Health Savings Account (HSAs) (if applicable).
Missing cafeteria plan?
If an employer takes pre-tax payroll deductions without a proper cafeteria plan document, the IRS could argue that the employer should treat those deductions as taxable to the employee. This means the deductions would be taxable to the employee. It also means the employer should have withheld income and payroll taxes on those deductions. The IRS could also assess penalties against the employer and require employees to amend their tax returns.
So many employers allow pre-tax payroll deductions that cafeteria plan compliance is sometimes overlooked. However, open enrollment season is a good time to check up on your cafeteria plan to make sure it is in place and up to date. If you’ve changed your benefit offerings or adjusted the amount or kinds of pre-tax contributions employees can make, some change in your cafeteria plan may be required. Please contact your HUB advisor if you have any questions.
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