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September 1, 2010

HRB 17 - Simple Cafeteria Plans

Released September 1, 2010I Download as a PDF

September 1, 2010 --  Included in the PPACA is a provision for a so-called, “simple cafeteria plan”.  A cafeteria plan, pursuant to IRC §125, is a plan that allows employees to purchase certain benefits on a tax-favored basis.  In effect, a cafeteria plan allows an employee to choose between tax-favored benefits, such as health coverage, life insurance coverage, or dependent care assistance, among others, and taxable compensation. 

Cafeteria plans are subject to specific discrimination rules.  The purpose of these rules is to ensure that highly compensated individuals do not unduly benefit from the program.  There can be as many as 10 or more discrimination testing rules that must be satisfied by a particular cafeteria plan.  Not only does the cafeteria plan have a series of discrimination rules, but so do its component plans.  The simple cafeteria plan exempts the plan from many of these discrimination tests; but, in return for this exemption, the simple cafeteria plan must comply with certain requirements, as described below.

The simple cafeteria plan is exempt from the general cafeteria plan discrimination rules, including the eligibility and benefits test, the key employee concentration test, as well as the discrimination rules applicable to group term life insurance, found in IRC §79d, the rules applicable to self-funded health plans, including flexible medical spending accounts, found in IRC §105(h); and the dependent care assistance plan discrimination rules, found in IRC §129(d). 

Important note: it is not clear whether the simple cafeteria plan is exempt from the salary-based discrimination rules applicable to insured plans, added by the PPACA and found in the Public Health Service Act §2716.  This section of the law is not specifically mentioned in the simple cafeteria plan rules.  Whether this is an oversight or intentional, is unclear and guidance would be welcome.

To qualify for a simple cafeteria plan, the plan must meet all of the following criteria:

  1. Eligible Employer.  To be an employer eligible to sponsor a simple cafeteria plan the employer must have employed an average of 100 or fewer employees on business days during either of the 2 preceding years. 

Growing Employers.  Special rules apply to a ‘growing employer’, in the event that its employee population exceeds 100 employees. The employer can continue to sponsor a simple cafeteria plan; however, in the year following a year in which the employer employs on average 200 or more employees on business days, the plan must be converted to a classic cafeteria plan.

Aggregation Rules.  Related employers, as defined in IRC Section 52(a), Controlled Group of Corporations, or Section 52(b), Employees of Partnerships, Proprietorships, Etc., Which Are Under Common Control, must be combined in determining employer size.  In addition, leased employees, as defined in IRC §§414(n) or (o), are counted in determining employer eligibility.

  1. Minimum eligibility and participation requirements.  Simple cafeteria plans must meet minimum eligibility and participation requirements.  Specifically, all employees who had at least 1,000 hours of service for the preceding plan year are eligible to participate.  Each employee eligible to participate in the plan may, subject to terms and conditions applicable to all participants, elect any benefit available under the plan.

Excludable Employees

Certain employees may be excluded from the minimum eligibility and participation requirements; these include:

  • Employees who are under age 21;
  • Employees who have been employed for less than one year;
  • Employees covered by a collective bargaining agreement where health benefits have been the subject of good faith bargaining; and
  • Nonresident aliens with no U.S. source of income.
  1. Contribution requirement.  The employer is required, without regard to whether a qualified employee makes any salary reduction contribution, to make a contribution to provide qualified benefits under the plan, on behalf of each qualified employee.  Qualified employees are those employees who are neither highly compensated individuals or key employees, as defined by the cafeteria plan rules, and who are eligible to participate in the cafeteria plan. 

There are two types of employer contributions, as follows:

  • The non-elective contribution is a uniform percent of compensation, but not less than 2% of the employee’s compensation for the plan year.
  • The matching contribution is an amount that equals or exceeds the lesser of:
  • Six percent of the employee’s compensation for the plan year; or
  • Twice the employee’s salary reduction contribution. 

The contribution method selected must be the same for all qualified employees, and must be a true employer contribution, i.e., it cannot include a salary reduction contribution at all. 

In conclusion, a simple cafeteria plan may be very useful to an employer who would otherwise have difficulty passing the myriad of discrimination rules otherwise applicable to cafeteria plans.  It is not, however, an appropriate vehicle for all employers; particularly for those employers who do not have the financial resources to allocate to the plan. 

Following are some questions to be answered in determining whether a simple cafeteria plan is appropriate:

  1. Is the employer, including related employers as described above, an eligible employer?
  2. In the absence of a cafeteria plan, would it be difficult to satisfy the discrimination testing?
  3. What will be the required contribution?  Is the employer in a position to satisfy this contribution requirement?

If it is determined that a simple cafeteria plan is appropriate:

  1. Define the plan terms, including eligibility requirements and contribution requirements.
  2. Adopt a new simple cafeteria plan, or amend an existing cafeteria plan.
  3. Communicate the new plan terms to your employees
  4. Regularly monitor status as an eligible employer.

 

About the Author:  Karen R. McLeese is Vice President of Employee Benefit Regulatory Affairs for CBIZ Benefits & Insurance Services, Inc., a division of CBIZ, Inc.  She serves as in-house counsel, with particular emphasis on monitoring and interpreting state and federal employee benefits law.  Ms. McLeese is based in the CBIZ Leawood, Kansas office.

 

 

The information contained herein is not intended to be legal, accounting, or other professional advice, nor are these comments directed to specific situations. The information contained herein is provided as general guidance and may be affected by changes in law or regulation. This information is not intended to replace or substitute for accounting or other professional advice. You must consult your own attorney or tax advisor for assistance in specific situations.

This information is provided as-is, with no warranties of any kind. CBIZ shall not be liable for any damages whatsoever in connection with its use and assumes no obligation to inform the reader of any changes in laws or other factors that could affect the information contained herein.

As required by U.S. Treasury rules, we inform you that, unless expressly stated otherwise, any U.S. federal tax advice contained herein is not intended or written to be used, and cannot be used, by any person for the purpose of avoiding any penalties that may be imposed by the Internal Revenue Service.

 

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