IRS Rules

The cafeteria plan document: what it must say.

Section 125 requires a cafeteria plan to exist in writing and to be run according to that writing. Employers who rely on pre-tax premiums should know what the document needs to cover.

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What To Know

What the law requires.

A Written Plan

The Internal Revenue Code defines a cafeteria plan as a written plan under which all participants are employees and can choose between cash and qualified benefits. The plan must be operated in accordance with its written terms. Ask your advisor or counsel to confirm that your plan document and daily practice match.

Cash Choice Is Required

A cafeteria plan must let employees choose between at least one taxable benefit, such as cash, and at least one qualified nontaxable benefit. Under IRS proposed regulations, a plan that offers only a choice among nontaxable benefits is not a cafeteria plan. Ask your tax adviser or counsel to confirm that your plan document offers the required choice.

What The Proposed Rules Add

Proposed regulations would require the document to describe all benefits, eligibility, how elections are made, the plan year, how employer contributions are made and the maximum elective contributions, and to say elections are irrevocable except for allowed changes in status.

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What To Do

What plan sponsors can do.

Confirm A Document Exists

Ask your advisor or administrator for the current signed plan document and keep it with plan records. Many employers assume their administrator has one, so ask for a copy now. The document should be signed and dated, name the benefits offered, and be available if an auditor or employee asks to see it. Keep older versions as well.

Match Operation To The Document

Elections, mid-year changes and employer contributions should follow what the document says. If practice drifts from the document, such as allowing a mid-year change the plan does not permit, the tax treatment can be questioned. Review the rules with your administrator at each open enrollment and whenever you change a process.

Update For Changes

If benefits, plan year or rules change, have the document amended in writing. Amendments should be dated, signed, and filed with the original. Build a review into the calendar each renewal, and ask your administrator or counsel whether the amendment is needed before the change takes effect rather than afterward.

What To Ask

Three questions to settle.

Is The Document Current

Check the plan year and the list of benefits. Compare the effective dates, the benefits, and the eligibility rules against what you actually offer. A document that was right three years ago may no longer describe your plan, and outdated terms can cause trouble in an audit.

Does It Cover Any FSA Rules

FSAs carry additional requirements, including uniform coverage and use-or-lose provisions. If your plan includes health or dependent care accounts, the document should address those rules. Ask your administrator to point to the section that covers them, and have your tax adviser or counsel review it.

Who Maintains It

Name the person or firm that keeps it updated. Put the name in the file, along with a backup contact. If the responsible person leaves, someone else should know where the document is kept and how to request an update or an amendment.

What The Statute Says

What Section 125 Requires Of A Cafeteria Plan

A Written Plan Is Required

Section 125 defines a cafeteria plan as a written plan. Without a written document, the tax exclusion for employee elections is at risk. If you find that you have been operating without a written document, talk to your tax adviser or counsel promptly about how to correct it. Do not wait for renewal or an audit to raise the question.

Employees Choose Between Benefits

Participants must be able to choose between cash, or another taxable benefit, and at least one qualified benefit. They may then choose among the qualified benefits the plan offers. Making a choice does not by itself make the amount taxable, provided the plan meets the Section 125 rules. Confirm the details with your tax adviser or counsel.

Only Employees Participate

The definition requires that all participants are employees, which matters when owners or other non-employees are included in a plan. Owners in some business structures may not be treated as employees for this purpose. Ask your tax adviser or counsel how your ownership structure is treated before including owners or relatives in a plan.

Qualified Benefits Only

Benefits offered must be excludable from income under an express Code provision, with specific exceptions listed in the statute. Whether a particular benefit qualifies depends on the Code provision behind it and the way the plan is built. Ask your tax adviser or counsel to confirm before adding a new benefit to the plan.

Some Benefits Are Excluded

Products marketed as long-term care insurance cannot be offered, and Exchange qualified health plans are generally excluded unless the employer is a qualified employer. These rules are technical and can change, so confirm with your tax adviser or counsel before you add a benefit that looks unusual. Your administrator can also tell you which products it supports.

No Deferred Compensation

A plan that provides deferred compensation is not a cafeteria plan, with limited statutory exceptions including contributions to health savings accounts. Retirement-type features and carryover arrangements can raise this issue, so ask your tax adviser or counsel to review any feature that lets employees defer pay into a later year.

Source: 26 U.S.C. 125.

Common Questions

Common Questions About Cafeteria Plan Documents

Do pre-tax premiums need a plan document?

Pre-tax salary reduction is made through a cafeteria plan, and a cafeteria plan must be in writing.

Are the proposed regulations final?

The description above comes from proposed regulations published in 2007. Check current status with counsel.

Can only employees participate?

Yes. The statute requires that all participants be employees.

Does the IRS approve the document?

The IRS has said it does not issue rulings on whether a plan satisfies section 125.

What if elections change mid-year?

Elections are irrevocable except as the plan permits under the change in status rules.

Is this legal advice?

No. For your plan, involve your counsel or tax advisor. We can help you organize your documents and questions.

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Let’s Get to Work

Send us your renewal.

We’ll tell you whether it looks competitive, where we see opportunity, and the five questions we’d put to your carrier. No cost, and no obligation to move anything.

What to send

The renewal letter
Your current plan summary
Contribution split by tier
Enrolled counts by tier

Four documents — two more if your group is 50 or more. Nothing else; every extra one is a reason to postpone.

Sources

Laws and rules referenced

26 U.S.C. § 125 — Cafeteria plans: pre-tax premium payments, plan limits and nondiscrimination rules.

IRS Publication 15-B — Employer’s tax guide to fringe benefits, including cafeteria plan and transportation benefit rules.

This page is general information, not legal or tax advice. Rules change and facts matter, so confirm your situation with counsel or a qualified advisor.

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