Cafeteria and Flexible Benefit Plans

If you provide employees with a benefits package consisting of several amenities, you'll need to familiarize yourself with U.S. Internal Revenue Code Section 125, the portion of the tax code that describes these plans. We'll describe the benefits packages likely to fall under this Code, how they differ, and what the reporting requirements are.

What are flexible benefit plans?

"Flexible benefit plan" and "flex plan" are general terms that describe benefit plans that allow employees to choose from a menu of different benefits, such as group-term life insurance, dependent care assistance, 401(k) plans, and health insurance.

What are cafeteria plans and how do they differ from flexible benefit plans?

"Cafeteria plan" is the term specifically used in Internal Revenue Code Section 125 to describe tax-preferred plans that let employees choose between cash, which is taxable, and a selection of nontaxable benefits.

Who pays for flexible benefits?

There are two ways to fund flexible benefit plans:

Flexible dollars or credits When flexible benefits are funded by the employer, each employee receives a designated number of flexible dollars or credits. Employees use flex dollars to purchase benefits from a menu of options, or they can elect to receive the flex dollars in cash.

Salary reduction When employees fund flexible benefits, they agree to having their pre-tax salaries reduced by the amount necessary to purchase the tax-preferred benefits that they select. Deductions from employee's after-tax wages also may be used to purchase any taxable benefits outside the formal cafeteria plan that also are offered on the employer's flexible benefits menu, such as club dues.

What are flexible spending accounts?

Many flexible benefits plans offer flexible spending accounts (FSAs), which allow employees to pay for qualified expenses—including medical, dental, vision, or child care expenses—with pre-tax dollars. Prior to the beginning of each plan year, employees elect the amount of salary-reduction dollars or flexible credits they wish to allocate to an FSA. As they spend money on qualified expenses, they can be reimbursed by the employer (or an FSA administrator) up to the amount they've contributed. Any amounts remaining in the FSA 90 days after the end of the plan year must be forfeited by the employee.

How are flexible benefit plans structured?

Premium-Only Plans (POPs) are used by small businesses that require their employees to contribute toward benefits. These plans don't offer a menu of benefit options like other flexible benefits plans do, but they do allow employees to pay their share of benefit costs on a pre-tax basis, so employees benefit from a Section 125 tax break even when employers can't afford an elaborate benefit plan.

Add-On Flexible Benefits Employees are given an allowance of flexible credits to apply toward optional benefits as a supplement to an existing non-flexible benefits package,. If the additional benefits cost less than the allowance, the excess allowance is paid to the employee in cash. If the additional benefits cost more than the allowance, the employee pays for the additional cost with after-tax income.

Shrink-to-Core Approach Similar to an Add-on Flexible Benefits plan, employees are given a non-flexible "core" benefits package, which usually include medical and life insurance. In addition, employees get an allowance of flexible credits to apply toward optional benefits. If the additional benefits cost less than the allowance, the excess allowance is paid to the employee in cash.

Modular Approach The employer offers a choice of several pre-configured benefit packages designed for selected employee groups, such as young single employees, single parents, married workers with dependents, and those nearing retirement. These modular packages are of roughly equal value, but offer a combination of benefits that are tailored to the needs of particular types of employees. These plans are generally simpler to administer than totally flexible plans that are tailored to each individual employee.

What are the tax advantages of flexible benefit plans?

Benefits are generally paid for with pretax credits or through salary reduction so that employees can save both federal and state income taxes, as well as FICA taxes. This means that if you're the employer, you'll pay less FICA, FUTA (Federal Unemployment Tax Act) and state taxes because your employees' gross taxable incomes have been marginally reduced. Be aware that New Jersey and Pennsylvania and several cities, including Kansas City, MO., St. Louis, MO, Cleveland, OH, and Philadelphia, PA, do not allow an exclusion of these amounts for income tax purposes.

Are there other advantages to flexible benefit plans?

Adherents say that the very "flexibility" implied is a plus when configuring benefits packages for workers with different needs. Because the plans permit employers to decide how much they wish to allocate for benefits in advance of each plan year, employers gain more control over benefits costs than found under traditional plans that commit an employer to providing a specific level of coverage. But critics of these plans point to their administrative complexity as a potential drawback.

If I institute a flexible benefits plan, how do I report it to the IRS?

You'll need to file a Form 5500 Employee Benefit Plan return. You can download the form in Adobe Acrobat format from the IRS Web site, and you'll need Adobe Acrobat Reader to read and print the form.

Form 5500

• For companies with fewer than 100 employees
• For companies with more than 100 employees

Additionally, reimbursements for childcare covered under the benefits plan must be reported on the employee's W-2 form under Box 10, "Dependent Care Benefits." Currently, general medical expense reimbursements need not be reported.

Where can I obtain more information about cafeteria and flexible benefit plans?

Here are some helpful sources:

IRS Form 5500 Info - A description of what information needs to be included on the Employee Benefit Plans, 5500 series. (Internal Revenue Service)

Cafeteria Plan Basic Tax Info -Defines the different types of plans, terms associated with them,and the reporting requirements you must fulfill. (Internal Revenue Service)

Cafeteria Plan Advantages for Employers -Brief article describes the basics of these plans and how they benefit companies who implement them. (Benefit Sources & Solutions)

Benefits Of A Cafeteria Health Plan -Article also offers tips on cafeteria plan implementation for small businesses and professional practices. (Physician's News Digest)

Cafeteria Plans and State Regulations - Although much of this material is specific to the state of Kentucky, article provides a useful example of how state tax rules may impact the use of these plans. (Kentucky Dept. of Finance)

Flexible Benefits FAQ -Detailed, 25-question FAQ from a benefits-consulting firm addresses the issues that small businesses looking at these plans must deal with, as well as the advantages that accrue once these plans are in place. (Value Design)

Flexible Benefits Plan White Paper - How these plans should be implemented and administered. (Society For Human Resource Management)

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