Cafeteria Plans: Staying Compliant With the Rules

Cafeteria Plan Compliance

The IRS issued a host of rules that have impacted your cafeteria plan.

On Aug. 6, 2007, the IRS issued proposed regulations governing Section 125 plans Ñ aka cafeteria plans Ñ reflecting several changes occurring since 1997, as well as incorporating new guidance. A cafeteria plan is a plan named for Section 125 of the Internal Revenue Code and allows an employee to elect a non-taxable benefit (e.g., medical coverage) in lieu of a taxable benefit (compensation). Employees can be given the opportunity to receive medical, dental, vision and other qualified benefits and contribute to the cost on a pre-tax basis in lieu of receiving taxable wages.

Key Changes to Cafeteria Plans

The proposed regulations, although not final, became effective for plans effective on or after Jan. 1, 2009, and the IRS packed quite a bit into these regulations. The following are key changes finance leaders should already be aware of from both a plan document and operations standpoint:

  • Written plan documents are mandated.
  • Eligibility requirements state the individual must be an "employee," including common law, leased former employees and self-employed individuals. Coverage for a non-spouse or non-dependent is allowed but can't be provided on a pre-tax basis. New employees should make elections within 30 days of their hire date in order to make retroactive pre-tax contributions towards benefits available as of the first day of work.
  • Certain non-qualified benefits that can't be offered through a cafeteria plan include scholarships, educational assistance, fringe benefits, long-term care insurance and health reimbursement arrangements.
  • Qualified benefits that may be offered through a flexible spending account (FSA) are medical reimbursement, dependent care assistance and adoption assistance.
  • Employers can adopt a two-and-a-half month grace period after the end of the plan year for FSAs to continue incurring expenses.
  • For health savings accounts (HSAs), the plan must allow changes on at least a monthly basis.
  • The regulations clarify the documentation required for the substantiation expenses. For example, each expense should be individually substantiated by a third party. Additionally, the regulations include new guidance on how debit, credit and value cards can be used to pay for medical and other health care expenses.

Consequences for Noncompliance

Just like other employee benefits areas, there are consequences if the employer does not comply with the regulations. For example, if the employer does not have a written plan document, or if the plan document fails to comply with Section 125 of the Internal Revenue Code (including operational failures), then the plan may fail to maintain its status as a cafeteria plan resulting in tax consequences for the employer and employees. At that point, all employee pre-tax withholdings from the plan may revert to gross income to the employee.

Although there haven't been changes to the Section 125 regulations since 2007, other laws have impacted the cafeteria plan rules, such as HIPAA and the ACA, as noted by ADP's Workplace Compliance Spotlight. Thus, it's crucial to pull out that plan document and give it a thorough review along with your operations for compliance. Is it current with the proposed changes and with the remainder of changes in the proposed regulations? Is it current with other federal laws such as HIPAA and the ACA? Are you operating in accordance with your document? If not, the financial consequences can be significant.