During the past 20-plus years, the Internal Revenue Service (IRS) has issued, in dribs and drabs, regulations, notices and other guidance on Sec. 125 cafeteria plans. In proposed regulations effective in general for 2009 plan years, the IRS now has consolidated its cafeteria plan guidance, along with clarifying and elaborating on various cafeteria plan issues. The regulations are lengthy — 124 pages — so in this article we highlight some of the points that are most significant for employers that offer some type of cafeteria plan.
Keep in mind that the term “cafeteria plan” can encompass arrangements as simple as premium-only plans or flexible spending accounts (FSAs), those as elaborate as choice-making plans with employer credits and a wide selection of benefits, or something in between. These requirements for cafeteria plans apply to any of these types of arrangements.
The cafeteria plan must be in writing, and the plan must be operated in accordance with the written plan terms. The regulations specify all that must be included in the written plan document. Remember that the requirement that the plan be in writing applies to all types of cafeteria plans, even premium-only plans.
All participants in a cafeteria plan must be employees, which the regulations define to include common-law employees, leased employees and full-time insurance salespeople. Former employees, including laid-off employees and retirees, may participate, but the plan cannot be maintained predominantly for them. Spouses and dependents may receive benefits under the cafeteria plan, but cannot “participate” in the plan. Self-employed individuals, including sole proprietors, partners, directors and 2% shareholders in Subchapter S corporations, are not considered employees and thus may not participate in a cafeteria plan, but they could sponsor a plan for employees.
The regulations specify the kinds of benefits that can be included in a cafeteria plan. Of note:
- If Group-Term Life insurance is offered, employers must use Table I as the exclusive method of computing the cost of such coverage in excess of $50,000 (which is includible in an employee’s income). This provision is effective immediately.
- Individual Health insurance premiums, as well as an employee’s or former employee’s COBRA premiums, can be paid through a cafeteria plan (but not through an FSA).
- Among benefits defined as nonqualified (and a plan that offers nonqualified benefits is not considered a cafeteria plan) are contributions to Archer medical savings accounts, contributions to health reimbursement arrangements, Group Term Life insurance for spouses or dependent children, and elective deferrals to Sec. 403(b) plans.
- A change in plan year, or a short plan year (less than 12 months), is only permitted for a valid business purpose.
- Though a cafeteria plan may not provide for deferred compensation, the regulations specify certain types of plan features that are not considered deferred compensation, such as a Long-Term Disability policy paying benefits for more than one year, certain two-year lock-in vision and dental policies, and certain advance payments for orthodontia.
- Though cafeteria plan elections generally are irrevocable (other than for changes in status or life events), the regulations permit employees to prospectively elect, revoke or change salary reduction elections for HSA contributions at any time during the plan year with respect to salary that has not become currently available at the time of the election. The regulations also permit automatic default elections for employees who fail to actively elect, and they permit new employees to make elections within 30 days of hire that are retroactive to the date of hire.
- Health FSAs may be established for limited purposes, such as an HSA-compatible limited-purpose health FSA or a post-deductible health FSA. Also, an employer can limit FSA enrollment to employees who participate in the health plan. A dependent care FSA may allow terminated employees to spend down their account through the end of the plan year. Employers can retain FSA forfeitures, use them to defray administrative expenses, or allocate them to participants.
- The regulations provide guidance on cafeteria plan nondiscrimination tests, define several key terms (including highly compensated individual, 5% shareholder, key employee and compensation), and specify that nondiscrimination testing must be performed on the last day of the plan year. They also create a nondiscrimination testing safe harbor for premium-only plans.
With this consolidated package of guidance for cafeteria plans, the IRS is likely to take enforcement more seriously. Now would be a good time to go through your cafeteria plan written document and administrative procedure and check for any compliance issues. Call us. We can help.