1013A cafe­te­ria plan is an employ­er-pro­vid­ed writ­ten plan that offers employ­ees the oppor­tu­ni­ty to choose between at least one per­mit­ted tax­able ben­e­fit and at least one qual­i­fied employ­ee ben­e­fit. There is no fed­er­al law that requires employ­ers to estab­lish cafe­te­ria plans; how­ev­er, some states require employ­ers to have cafe­te­ria plans for employ­ees to pay for health insur­ance on a pre-tax basis.

To com­ply with Inter­nal Rev­enue Code Sec­tion 125, a cafe­te­ria plan must sat­is­fy a set of struc­tur­al require­ments and a set of nondis­crim­i­na­tion rules. Vio­la­tions of the struc­tur­al require­ments will dis­qual­i­fy the entire plan so that no employ­ee obtains the favor­able tax ben­e­fits under Sec­tion 125, even if the plan meets the nondis­crim­i­na­tion rules. Vio­la­tions of the nondis­crim­i­na­tion rules have adverse con­se­quences only on the group of employ­ees in whose favor dis­crim­i­na­tion is prohibited.

A cafe­te­ria plan must pass an eli­gi­bil­i­ty test, a con­tri­bu­tions and ben­e­fits test, and a con­cen­tra­tion test for high­ly com­pen­sat­ed indi­vid­u­als to receive the tax ben­e­fits of Sec­tion 125. Fail­ure to meet these nondis­crim­i­na­tion require­ments has no effect on non-high­ly com­pen­sat­ed cafe­te­ria plan participants.

The IRS issued pro­posed cafe­te­ria plan reg­u­la­tions on August 6, 2007. Final reg­u­la­tions have not been issued. Accord­ing to the pro­posed reg­u­la­tions, tax­pay­ers may rely on the pro­posed reg­u­la­tions for guid­ance pend­ing the issuance of final regulations.

The pro­posed cafe­te­ria plan reg­u­la­tions make it clear that the plan must meet the nondis­crim­i­na­tion tests. Also, the plan must not dis­crim­i­nate in favor of high­ly com­pen­sat­ed par­tic­i­pants in its oper­a­tion. For exam­ple, a plan might be con­sid­ered dis­crim­i­na­to­ry if adop­tion assis­tance is added to the plan when the CEO is in the process of adopt­ing a child and adop­tion assis­tance is dropped when the adop­tion is final.

Be aware that Sec­tion 125 nondis­crim­i­na­tion rules are sep­a­rate from and unre­lat­ed to Sec­tion 105(h) nondis­crim­i­na­tion rules. Fur­ther, Sec­tion 125 nondis­crim­i­na­tion rules apply to all cafe­te­ria plans regard­less of their sta­tus as ful­ly insured, self-fund­ed, church plan, or gov­ern­men­tal plan.

As a prac­ti­cal mat­ter, these nondis­crim­i­na­tion rules pro­hib­it exec­u­tive health plans offered through a cafe­te­ria plan.

Nondis­crim­i­na­tion test­ing can help employ­ers avoid rule vio­la­tions. But there are a num­ber of def­i­n­i­tions of key terms used in the tests that must be under­stood pri­or to com­plet­ing the tests:

High­ly Com­pen­sat­ed Indi­vid­u­als. High­ly com­pen­sat­ed indi­vid­u­als are defined as:

  • Offi­cers
  • Five per­cent shareholders
  • High­ly com­pen­sat­ed employ­ees (HCEs)
  • Spous­es or depen­dents of any of the pre­ced­ing individuals

High­ly Com­pen­sat­ed Par­tic­i­pant. A high­ly com­pen­sat­ed par­tic­i­pant is a high­ly com­pen­sat­ed indi­vid­ual who is eli­gi­ble to par­tic­i­pate in the cafe­te­ria plan.

Offi­cers. Offi­cers include any indi­vid­ual who was an offi­cer of the com­pa­ny for the pri­or plan year (or cur­rent plan year in the case of the first year of employment).

Five Per­cent Share­hold­ers. Five per­cent share­hold­ers include any indi­vid­ual who – in either the pre­ced­ing plan year or cur­rent plan year – owns more than five per­cent of the vot­ing pow­er or val­ue of all class­es of stock of the employ­er, deter­mined with­out attribution.

High­ly Com­pen­sat­ed. High­ly com­pen­sat­ed means any indi­vid­ual or par­tic­i­pant who – for the pri­or plan year or the cur­rent plan year in the case of the first year of employ­ment – had annu­al com­pen­sa­tion from the employ­er in excess of the com­pen­sa­tion amount spec­i­fied in the Inter­nal Rev­enue Code and, if elect­ed by the employ­er, was also in the top-paid group of employ­ees for the year. For 2016, the applic­a­ble com­pen­sa­tion amount is $120,000.

Key Employ­ee. A key employ­ee is a par­tic­i­pant who, at any time dur­ing the plan year, is one of the following:

  • An offi­cer with annu­al com­pen­sa­tion greater than an indexed amount ($170,000 for 2016)
  • A five per­cent own­er of the employer
  • A one per­cent own­er hav­ing com­pen­sa­tion in excess of $150,000


Orig­i­nal­ly pub­lished by Unit­ed Ben­e­fit Advi­sors — Read More