3.15 Cafeteria Plans Provide Choice of Benefits

“Cafeteria plans” is a nickname for plans that give an employee a choice of selecting either cash or at least one qualifying nontaxable benefit. You are not taxed when you elect qualifying nontaxable benefits, although cash could have been chosen instead. A cafeteria plan may offer tax-free benefits such as group health insurance or life insurance coverage, long-term disability coverage, dependent care or adoption assistance, medical expense reimbursements, or group legal services. Long-term care insurance may not be offered through a cafeteria plan under current law.

Employees may be offered a premium-only plan (POP), which allows them to purchase group health insurance coverage or life insurance on a pre-tax basis using salary-reduction contributions.

Health savings accounts (HSAs) and their related high-deductible health plans (HDHPs) may be offered as options by a cafeteria plan (3.2). If so, employees may elect to have contributions made to an HSA and an HDHP on a pre-tax salary-reduction basis.

A cafeteria plan may also offer benefits that are nontaxable because they are attributable to after-tax employee contributions. For example, employees may be offered the opportunity to purchase disability benefits (short term or long term) with after-tax contributions. If a covered employee subsequently receives disability benefits that are attributable to after-tax contributions, the benefits will be tax free. On the other hand, the plan may allow employees to elect paying for disability coverage on a pre-tax basis and, in this case, any benefits from the plan attributable to the pre-tax contributions will be taxable when received.

Under a flexible spending arrangement (FSA), employees may be allowed to make tax-free salary-reduction contributions to a medical or dependent care reimbursement plan (3.16).

A qualified cafeteria plan must be written and not discriminate in favor of highly compensated employees and stockholders. If the plan provides for health benefits, a special rule applies to determine whether the plan is discriminatory. If a plan is held to be discriminatory, the highly compensated participants are taxed to the extent they could have elected cash. Furthermore, if key employees (3.4) receive more than 25% of the “tax-free” benefits under the plan, they are taxed on the benefits. Employers averaging 100 or fewer employees who agree to contribute a fixed amount towards benefits are treated as meeting the nondiscrimination tests under special rules for “simple” cafeteria plans.