Tag: Section 125

Section 125: Cafeteria Plan Common Questions

A Section 125 plan, or a cafeteria plan, allows employers to provide their employees with a choice between cash and certain qualified benefits without adverse tax consequences. Employees who participate in a cafeteria plan can pay for qualified benefits, such as group health insurance, on a pretax basis. This reduces both the employees’ and the employer’s tax liability. Once an employee makes a cafeteria plan election, he or she may not change that election until the next plan year, unless the employee experiences a permitted election change event. Download the PDF version: Section 125: Cafeteria Plan Common Questions.pdf This Compliance Overview is not intended to be exhaustive nor should any discussion or opinions be construed as legal advice. Readers should contact legal counsel for legal advice. © 2010-2012, 2015-2019 MyTPG.com. All rights reserved. This irrevocability requirement can be a disadvantage to participating in a cafeteria plan. Also, while the employer may reduce its tax liability by offering a cafeteria plan, it is responsible for the costs of establishing and maintaining the plan. HIGHLIGHTS EXAMPLES OF QUALIFIED BENEFITS Medical plan coverage Dental and vision coverage Health FSAs Dependent care FSAs HSAs Life insurance coverage Disability benefits NONDISCRIMINATION TESTS In general, a cafeteria plan must satisfy the following three nondiscrimination tests: The eligibility to participate test; The benefits and contribution test; and The key employee concentration test. Also, to receive the tax advantages associated with a cafeteria plan, the plan must generally pass certain tests that are designed to ensure that the plan does not discriminate in favor of highly compensated employees. Section 125/Cafeteria Plan Basics LINKS AND RESOURCES Internal Revenue Code Section 125 IRS’ proposed Section 125 regulations from 2007 – Taxpayers may rely on these regulations until final regulations are issued. What is a Section 125 plan? A Section 125 plan allows employees to purchase qualified benefits, such as health insurance, with pretax dollars. The rules in Section 125 of the Internal Revenue Code (Code) make this possible. A Section 125 plan is also commonly referred to as a cafeteria plan. The four basic forms of Section 125 plans are: Premium Only Plan Flexible Spending Account Full Cafeteria Plan Simple Cafeteria Plan What is a premium only plan? A premium only plan is the most basic—and most popular—type of Section 125 plan. A premium only plan, or POP, allows employees to pay their portion of insurance premiums with pretax dollars. Benefits that are typically offered within a premium only plan include health, dental, vision, accidental death and dismemberment, short- and long-term disability, and group-term life insurance on the life of the employee. What is a flexible spending account? Under Code Section 125, employees may make pretax contributions to a flexible spending account (FSA). An employee may seek reimbursement from the FSA for expenses paid for child care, health plan deductibles and eligible medical expenses not otherwise covered under a health plan. An FSA allows employees to increase their spendable income by allowing them to pay these expenses with pretax dollars. There are three types of benefits that may be offered through an FSA: Medical care reimbursement (that is, a health FSA);  Dependent care assistance; and Adoption assistance. FSAs are subject to the “use-it-or-lose-it” rule. Thus, any money remaining in the FSA at the end of the Section 125 plan year (or grace period, if applicable) is forfeited. However, the IRS has relaxed the use-or-lose rule for health FSAs. Under the relaxed rule, employers may allow participants to carry over up to $500 in unused funds into the next year. This modification applies only if the plan does not also incorporate a grace period. What is dependent care assistance? Dependent care assistance (dependent care FSA) allows an employee to set aside pretax dollars in order to pay for day care expenses. Expenses for food, education or medical care may not be reimbursed from a dependent care FSA. In order for dependent care expenses to be eligible for reimbursement, they must: Allow the employee or the employee’s spouse to be gainfully employed or to attend school; and Ensure a qualified dependent’s well-being and protection. A qualified dependent is a child under the age of 13 or a spouse that is incapable of self-care. There is a statutory limit on the amount of expenses that can be paid pretax under a dependent care FSA. The limit is calculated on a calendar-year basis and is equal to the smallest of the following amounts: $5,000 (if the employee is married and filing a joint return or is a single parent); $2,500 (if the employee is married but filing separately); The employee’s earned income; or The spouse’s earned income (if the employee is married at the end of the taxable year). If a spouse is not gainfully employed because he or she is a full-time student or is incapable of self-care, then the spouse will be deemed to have an income of $250 per month for one qualifying individual, or $500 per month for two or more qualifying individuals. The dependent care FSA is subject to the use-it-or-lose-it rule. Therefore, money remaining in the account at the end of the Section 125 plan year (or grace period, if applicable) is forfeited. What is a health FSA? A health FSA allows an employee to set aside pretax dollars in order to pay for eligible medical expenses not covered by insurance. Eligible medical expenses must be incurred: During the current health FSA plan year (or grace period, if applicable); and By the employee, employee’s spouse or dependent. Beginning in 2013, the Affordable Care Act (ACA) imposed a $2,500 limit on salary reduction contributions to a health FSA. This limit applies on a plan year basis to grandfathered and non-grandfathered health FSAs, and is indexed for cost-of-living adjustments for 2014 and later years (for 2020, the limit is $2,750). Employers may impose their own limits on employee health FSA contributions, as long as the employer’s limit does not exceed ACA’s maximum limit. Health FSAs are subject to the use-it-or-lose-it rule. […]

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