Offering Employees Pre-Tax Benefits? You Need a Cafeteria Plan
With few exceptions, the premium costs paid by employees for group health benefits are paid with pre-tax dollars. In other words, the employee’s portion of healthcare premiums is taken out of the employee’s pay before the employer withholds taxes.
Using pre-tax dollars benefits employees because it results in a smaller tax burden. However, employers must not overlook that the federal tax rules require employers to adopt a written cafeteria plan in order for the employer to permit employees to elect to pay for certain eligible benefits with pre-tax dollars.
A cafeteria plan, as defined in the tax code, is a written plan permitting eligible employees to choose among two or more benefits consisting of cash and qualified benefits. Not all benefits fall under the umbrella of cafeteria plan rules, but many do, including: healthcare premiums, flex-spending accounts, dental and vision premiums, and employee and employer HSA contributions. Additionally, the cafeteria plan details the employee’s option to elect tax-favored benefits paid for with the employee’s pre-tax contributions and any employer contributions or credits. For example, if an employer offers reimbursement for dependent care expenses, the cafeteria plan would describe things such as the maximum reimbursement amount, the deadline to incur expenses, and the deadline to submit claims for reimbursement.
Without a written cafeteria plan, any employee-paid benefits must be paid with after-tax dollars and employer-provided flex credits will be taxable income to the employee. In the event of an IRS audit, failure to adopt a written cafeteria plan and comply with the tax code subjects employees to additional taxable compensation and employers to tax reporting and withholding penalties.
Although adopting a written cafeteria plan may seem daunting, the cost of compliance is relatively low compared with the potential penalty (and uncertainty) of noncompliance. Once the plan is created, there will be relatively modest ongoing time and expense necessary for updating the plan as the employer changes benefit offerings or changes occur to applicable tax rules.
If your company needs a cafeteria plan, contact Barrett McNagny to speak with one of our attorneys, who have experience assisting clients with their cafeteria plan documents and compliance assistance.