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How does a
cafeteria plan work?
Code
section 125 makes it possible for employers to offer their employees a
choice between cash salary and a variety of nontaxable benefits
(qualified benefits).
A qualified benefit is a benefit that does not defer compensation and is
excludable from an employee’s gross income under a specific provision of
the Code, without being subject to the principles of constructive
receipt. Qualified benefits include health care, vision and dental care,
group-term life insurance, disability, adoption assistance and certain
other benefits. See Sections 125(a), 125(f), 79, 105, 106, 129 and 137
of the Code.
Employers may also offer flexible spending accounts to employees under a
cafeteria plan that provides coverage under which specified, incurred
expenses may be reimbursed. These include health flexible spending
accounts for expenses not reimbursed under any other health plan and
dependent care assistance programs.
Employer contributions to the cafeteria plan are usually made pursuant
to salary reduction agreements between the employer and the employee in
which the employee agrees to contribute a portion of his or her salary
on a pre-tax basis to pay for the qualified benefits. Salary reduction
contributions are not actually or constructively received by the
participant. Therefore, those contributions are not considered wages for
federal income tax purposes. In addition, those sums generally are not
subject to FICA and FUTA. See Sections 3121(a)(5)(G) and 3306(b)(5)(G)
of the Code.
The above discussion provides only the most basic rules governing a
cafeteria plan. For a complete understanding of the rules, see the
proposed and final regulations under Code section 125.
Further information from IRS on how cafeteria plans work
Employers guide to fringe benefits
Source: IRS
01.20.2011 |