Frequently Asked Questions
1. What is a cafeteria plan?
A Cafeteria Plan is a plan established by an employer in accordance with the requirements prescribed by Internal Revenue Code (I.R.C.) Section 125. A cafeteria plan is an exception to the 'constructive receipt rule' and allows certain employees to pay for certain benefits with pre-tax salary reductions. Certain benefits such as health insurance, life insurance and disability insurance may be offered through the cafeteria plan so the employees may pay their share of such benefits with pre-tax salary reductions, but the actual health, life and disability benefits are welfare benefits offered pursuant to separate welfare plans or a combined welfare plan. The cafeteria plan serves as a type of funding vehicle for the qualified benefits offered through the cafeteria plan. Cafeteria plans can include premium only plans, flexible spending accounts (FSA's) and contributions to health savings accounts. Contributions are not subject to federal, state or Social Security taxes.
2. What are the general legal requirements of a cafeteria plan?
- A plan established pursuant to a written plan document that satisfies certain content requirements;
- All participants must be "employees of the employer";
- The plan must provide employees with a choice between one or more permitted taxable benefits and one or more non-taxable qualified benefits;
- Generally, election must be made before the earlier of the date the permitted taxable benefit becomes available (date they could receive taxable salary) or start of the applicable coverage period and are generally irrevocable during the plan year unless certain specified exceptions apply; and
- The plan may not discriminate in favor of "highly compensated individuals" as to eligibility or benefits.
3. What are the benefits of implementing a cafeteria plan?
Benefits to the Employer
- Every dollar run through the 125 plan reduces an employer's payroll tax obligation. Therefore, you don't have to pay FICA or worker's compensation premiums on those dollars.
- Implementing a cafeteria plan can help offset the impact of premium increases to employees.
- Employees can use tax savings to invest in retirement plans. By using an FSA, your employees can save money on their everyday expenses, thus freeing up more of their income to be allocated to their 401(k) account, which increases participation in both plans.
Benefits to the Employee
- Participating in a cafeteria plan reduces an employee's taxable salary and increases the percentage of their take-home pay, thus increasing their spendable income.
- Employees typically receive a greater deduction on dependent care expenses than what's offered by a traditional tax credit at the end of the year.
- There's less of an impact on employees from insurance increases, such as premiums, co-pays, deductibles and so on. Through the use of an FSA, employees can set aside money to cover these increased amounts, which lessens their out-of-pocket costs because they're setting aside tax-free dollars.
Increased participation equals greater tax savings to the employer. Thus, to promote participation in the plan, employers may wish to contribute to each employee's FSA account (not to exceed two times the participant's election or $500, if greater.
4. What is a plan year and the irrevocability rule?
The coverage period is the 12 month operating period of the plan and generally begins on the first of a month. Many employers design their plan to run on the same plan year as their insurance program. Short plan years are allowed in certain instances.
The general rule is that elections are irrevocable during the plan year. The IRS Code permits participants to change their election during the plan year if they experience one of the following limited events as long as the change is consistent with an event that affects eligibility for coverage under an employer plan:
- Change of status event
- Change in cost of coverage
- One of the other enumerated events such as HIPAA special enrollment, FMLA leave, Medicare entitlement, etc.
Not all events allow changes to all benefits offered under the plan so check with All Valley Administrators on specific events and allowable changes.
5. What is a grace period and run out period?
The grace period is a brief timeframe of 2 months and 15 days (75 days) after the end of the official plan year during which employees may use up any funds they have remaining from the prior plan year. For example, if the plan year runs from January 1 to December 31, the grace period for that plan may continue up to March 15 of the next year. If an employee incurs an expense after December 31 but before March 15, they can utilize the remaining funds from the previous plan year and submit requests for reimbursement. In addition to the 2 1/2 month grace period, plan participants have an additional run-out period that is set by the employer and is generally 90 days, in which they can submit requests for reimbursement for expenses incurred within the plan year and grace period.
A run out period and grace period are two separate and distinct things. A run out period is a period following the end of the coverage during which expenses incurred during the coverage period may be submitted for reimbursement. A grace period is a period following the end of the plan year during which expenses incurred may be reimbursed with contributions from the prior year.
6. Is the healthcare FSA subject to the uniform coverage rule?
This aspect of Section 125 Healthcare FSA requires the maximum amount of reimbursement elected by a participant from a Healthcare FSA must be available at all times during the period of coverage, thus allowing a participants to be reimbursed for qualified medical, dental and vision expenses that exceed their contribution to date.
Uniform coverage applies to the Healthcare FSA only; it does not apply to Dependent Care FSA's. With a Dependent Care FSA account, a participant's reimbursement may not exceed the balance in the FSA account at the time the claim was made.
7. What are the use-or-lose rule and carryover provisions?
Under the use-or-lose rule participants must forfeit any healthcare FSA contributions made during a plan year that are not used for expenses incurred during the year or applicable grace period.
However, on October 31, 2013; the IRS provided a modification to the use-or-lose rule that permits cafeteria plans to allow up to $500 of unused amounts remaining at the end of a plan year in a healthcare FSA to be paid or reimbursed to plan participants for qualified medical expenses incurred during the following plan year, provided the plan does not also incorporate the grace period rule on the healthcare FSA.
8. Are there non-discrimination testing requirements?
The IRS establishes various tax related non-discrimination test for various benefit options that may be offered under a flexible benefits plan. These tests effectively prevent plan sponsors of those benefit options from discriminating in favor of highly compensated employees and in some cases key employees as to the eligibility to participate and the benefits offered under the plan. Employees of employers treated as a single employer under Code Section 414(b),(c) or (m) are included in the testing. The consequences of failing the tests generally results in highly compensated employees or key employees including the benefits as income. The employer/plan sponsor may also have withholding responsibilities on amounts included in income if the plan fails the applicable tests.
9. Are there any exceptions to who can participate in a cafeteria plan?
Individuals who are considered "self-employed" under Code are not "employees" and are not eligible to participate in a cafeteria plan. The following individuals are considered self-employed for this purpose:
- Sole proprietors
- Partners in a partnership
- More than 2% shareholder of subchapter S Corporation and the family members of the more than 2% shareholder, even if they are otherwise common law employees of the employer.
- Member of an LLC that is treated as a partnership for federal tax purposes.
Contact our Flexible Benefits team to work closely with you and your advisor to set up a new plan or transition your existing plan from your current provider. We help establish an action plan and have specific steps that are recognized to successfully implement the plan. We offer extensive enrollment and educational material that is also essential to the setup and execution of your plan.
Implementing a flexible benefits plan can be an intensive endeavor, but All Valley Administrators takes care of the hard work to make the entire process as easy and seamless as possible.