Some Basics on Cafeteria Plans for the Payroll Department

Kenneth M. Krum, CPP, payroll manager, KidsPeace Corp.

What is a Cafeteria Plan? The term describes an approach to compensating employees where they may choose from a “menu” of different benefit options according to Kenneth Krum, of KidsPeace Corporation.

Cafeteria plans provide employees a choice of two or more benefits consisting of cash and/or certain nontaxable benefits. “Flexible Benefits,” is a generic term applied to any type of arrangement that offers employees a choice among benefits. Section 125 of the Internal Revenue Code governs these plans. This section defines a cafeteria plan as an arrangement under which an employee has a choice between cash and/or “qualified benefits.” Qualified benefits elected under a cafeteria plan are not taxable to the employee. The benefits menu must include at least two benefits, allowing the employee to receive cash or one or more qualified (non-taxable) benefits. These benefits include: medical/dental, group term life insurance, disability/accident insurance, adoption assistance, dependent care and 401 (k) plans, flexible spending accounts, and elective vacation days .

The terms “cafeteria plan” and “flexible benefit plan” often are used interchangeably to describe menu-type benefit plans and services that allow employees to choose. Flexible benefit programs can be made as simple or as complex as the employer desires. Most company plans incorporate at least some features from the following “prototype” plans: premium-only plans, add-on flexible benefits, shrink–to-core approach, and the modular approach. Every company must choose the plan that is best of their company.

The IRS requires companies to qualify under Section 125. The cafeteria plan must be a written plan, intended to be permanent, and cannot discriminate in favor of highly compensated employees.

Generally, benefit elections under a cafeteria plan are irrevocable, but changes are permitted under certain conditions, such as if a third party health care provider significantly changes an employee’s coverage, the employee has a change in family status, and a change in employment status.

In addition, there are two types of flexible spending accounts that are separate from Section 125 cafeteria plans, and they cover medical expenses that are not paid for by insurance, and dependent care (up to a maximum of $5,000 per year). These plans allow employees to pay for certain expenses--health care and dependent care expense--on a pre-tax basis.

Employers with cafeteria plans are required to file an annual report using Form 5500. Employers must report dependent care spending account amounts paid under a plan on the employee’s Form W-2 in Box 10. Many employers report the employee contributions to a Section 125 plan or reimbursements made to employees under a medical FSA in Box 14 but this is optional. State and local governments do not consistently follow the federal standard with respect to payroll taxes and multistate employers have to use local tax treatments.

By Brigitta Robinson