Cafeteria Plan: Tax Advantaged Employee Benefit Plan
A Cafeteria Plan is a Flexible Spending Account (FSA), described under Section 125 of the Internal Revenue Code. A Cafeteria Plan allows employees to pay certain qualified expenses (such as health insurance premiums) on a pre-tax basis, thereby reducing their total taxable income and increasing their take-home pay. Funds set aside in FSAs are not subject to Federal, State, or Social Security taxes. Beginning in January 2013, medical Flexible Spending Account (FSA) contributions will be capped at $2,500 per year, per employee, as set forth by the Affordable Care Act.
Premium Only Plans (POP) Cafeteria Plan
Employers may deduct the employee’s portion of the company-sponsored group health insurance premium directly from said employee’s paycheck before taxes are deducted.
Flexible Spending Plans (FSA) Cafeteria Plan
Employees may set aside in a Flexible Spending Account (FSA) a pre-established amount of money per Plan year on a pre-tax basis. The employee can use the funds in the FSA to pay for eligible medical, dependent care, or transportation expenses.
Benefits to the Employer of Cafeteria Plan
Employers may add a FSA Plan as a key element in their overall benefit package. Because an FSA Plan offers a tax-advantage, employers experience tax savings from reduced FICA, FUTA, SUTA, and Workers’ Compensation taxes on participating employees. These tax savings reduce or eliminate altogether the various costs associated with offering the Plan. Meanwhile, employee satisfaction is heightened because participating employees experience a “raise” at no additional cost to the employer. Increased participation equals greater tax savings to the employer. Thus, to promote participation in the Plan, employers may wish to contribute to each employee’s FSA account.
Benefits to the Employee of Cafeteria Plan
An employee who participates in the FSA must place a certain dollar amount into the FSA each year. This “election” amount is automatically deducted from the employee’s check (for that amount divided by the number of payroll periods). For example, an employee is paid 24 times a year, and elects to put $480.00 in the FSA. Thus, $20.00 is deducted pre-tax from each paycheck and is held in an account (by the Plan administrator) to be reimbursed upon request.
Simple Cafeteria Plans
The Affordable Care Act amended the Internal Revenue Code and added regulations for the Simple Cafeteria Plan for small businesses (fewer than 100 employees). The major benefits of a Simple Cafeteria Plan are the ease of implementation, and the safe harbor granted from the nondiscrimination testing of the Internal Revenue Code. This is a great plan for a small company which has had trouble with nondiscrimination testing in the past and still wants to offer coverage to their employees.
Use-It-Or-Lose-It Rule of Cafeteria Plans
This rule states that any funds remaining in the participating employee’s FSA account at the end of the Plan Year will be forfeited to the employer. Although the rule is clear, many users of a FSA largely misunderstand the result of the rule: loss of funds can be easily avoided. Let’s look at an example: Joe Smith chooses to participate in the FSA and elects to fund $500 for the year. After the Plan year and Grace Period are complete, Joe finds that he spent only $400 of the original $500 he put away. He fears he has lost $100, but due to the taxes he saved on the $500 he has not. Let’s say Joe is in the 28% tax bracket. By putting $500 away in his FSA he saved $140 in taxes - that is money that was not taken out of his paycheck and given to the IRS. In sum, even if Joe leaves $100 in his FSA account, he has still saved $40! This vital key issue must be explained completely to potential FSA participants.
