THE only means an employer can offer employees between taxable and nontaxable benefits is through section 125 plan.
What are a section 125 plan, a cafeteria plan, and the IRS requirements for this plan?
1. Cafeteria Plan: Cafeteria plan is a written plan maintained by employer for employees that meets the requirements and regulations of section 125 of the Internal Revenue Code. The participants may receive benefits on a pretax basis and must have the option to choose at least one taxable benefit or cash and a qualified nontaxable benefit. It should specifically describe all benefits and establish rules for eligibility and elections.
2. Qualified benefits under the cafeteria plan rules: The qualified benefits include accident and health benefits but not archer medical savings accounts or long-term care insurance, adoption assistance, dependent care assistance, group-term life insurance coverage, and health savings accounts including distributions to pay long-term care services.
3. Premium-only or premium conversion plans: The employees premium contributions to employer-sponsored health and welfare plans may be made on a pretax basis. The sec.125 choice is between taxable salary and nontaxable contributions to a group health insurance plan.
4. Flexible reimbursement accounts or flexible spending accounts (FSA): The employees contribute and are reimbursed on a pretax basis for unreimbursed medical, dependent care, or adoption expenses. The sec.125 choice is between taxable salary and nontaxable contributions to a flexible spending account.
5. Three types of FSAs allowed under sec. 125: The three types of FSAs under sec 125 are: 1) health FSA, reimburses employees for health care expenses, 2) dependent care FSA, reimburses employees for certain child care expenses under IRC sec. 129, and 3) an adoption assistance FSA under IRC sec. 137. These types of plans could either be included in the sec 125. plan document or a separate written plan descriptions may be prepared.
6. Full flex or full cafeteria plans: Employees choose from a list of options of benefits selections. The sec.125 choice is between taxable salary and or taxable benefits and the employer’s nontaxable contributions to qualified benefits.
7. When is sec. 125 plan necessary? If an employer wants to give employees cash if they waive-out of the group health plan. If there is no sec.125 the group health plan would be taxed on the amount of the cash waiver even employees choose the group health plan.
8. Must be in writing: The plan document should be in writing and have to include the following: a specific description of each of the benefits available under the plan, including the periods during which the benefits are provided coverage period, the plan’s participation rules, the procedures governing participants’ elections under the plan, including the period during which elections may be made, the extent to which elections are irrevocable, and the periods with respect to which elections are effective, the manner in which employer contributions may be made under the plan, such as by salary reduction agreement between the participant and the employer or by non-elective employer contributions (flex credits) to the plan, the maximum amount of employer contributions available to any participant under the plan, the plan year on which the plan operates, for a plan that offers paid time off, the required ordering rule for use of non-elective and elective paid time off, for a plan that includes FSAs, the plan’s provisions complying with any additional requirements for those FSAs (for example: the uniform coverage rule and the use it-or-lose it rules), for a plan that includes a grace period, the plan’s provisions complying with the grace period requirements, and for a plan that includes distributions from a health FSA to employees’ HSAs, the plan’s provisions complying with related requirements.
9. Filing requirement of cafeteria plan. You may be required to file Form 5500 or Schedule F if you have a welfare benefit plan. If you only have cafeteria plan there is generally no filing requirement.
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Disclaimer: Any accounting, business or tax advice contained in this communication is neither intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties.
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Al-os & Associates Accountancy Corporation provides accounting and tax services to individuals, corporations, LLCs and business entities. The Firm has a niche in defending taxpayers audited by the IRS and other governmental agencies.