It has been said on more than one occasion that the U.S. tax code is overly complicated. If you have ever tried to set up or manage an employee cafeteria plan, you know exactly what this sentiment is all about. While cafeteria plans are great benefits to offer employees, they are terribly complicated for tax purposes. That is why companies offering cafeteria plans now look to third-party payroll and benefits administration providers more than ever before.
Cafeteria Plans Explained
What is a cafeteria plan? It is a plan through which employers can offer workers a handful of benefits under section 125 of the IRS regulations. Cafeteria plans are generally considered reimbursement plans. As such, they reimburse workers for certain kinds of expenses like health insurance and direct, out-of-pocket healthcare expenses.
There are two kinds of basic cafeteria plans:
- Premium Only Plan – Also known as a POP, this is a plan that provides health insurance to employees. The plan requires employees to pay 100% of their premiums via deductions from their paychecks. However, premium payments are taken out of gross pay rather than net. In other words, employees pay for their health insurance with pretax dollars.
- Flexible Spending Account – A flexible spending account (FSA) is a special kind of account into which contributions can be made via payroll deductions. The money in the said account can be used to pay for medical expenses, dependent day care, adoption fees, etc. Employees pay the fees upfront; the cafeteria plan manager then issues reimbursement.
Everything seems pretty simple so far. But wait, it is about to get complicated. Cafeteria plan contributions are not so straightforward when it comes to taxation. There are also strict guidelines as to what kinds of expenses can be covered with an FSA.
Federal Tax Implications
The primary advantage to cafeteria plans is that they are generally free of federal taxation. In most cases, a cafeteria plan is not subject to federal income tax, Social Security, Medicare, and unemployment taxes. But there is a loophole. If a cafeteria plan is used to purchase group term life insurance with the policy value in excess of $50,000, the money used to buy that policy is still taxable.
Adoption assistance benefits are also another issue. An employee could pay for adoption out of his or her FSA, but that money would still be subject to federal taxes. The payroll department would have to report the benefits before withholding the applicable taxes and combining them with regular federal tax payments.
Differences in State Laws
The cafeteria plan can get really tricky in some states with laws that differ heavily from federal regulations. For example, workers in New Jersey do not receive state tax relief on their cafeteria plans. The money contributed to their plans is still subject to state income tax.
Some states mandate that employers offer cafeteria plans under certain circumstances. Connecticut and Massachusetts are two examples. Employers in Connecticut are required to offer a cafeteria plan if they also offer a health insurance plan that is at least partially funded through employee payroll deductions. In Massachusetts, all employers with at least 11 employees must offer a POP at the bare minimum.
If you find cafeteria plans confusing, you are not alone. Despite being helpful to the employees who use them, cafeteria plans are quite complicated to administer. Here at BenefitMall, we are experts in all things payroll and benefits. We can help your company make sense of your cafeteria plan, health insurance plan, and even your worker's comp insurance. We offer effective and affordable solutions for companies of all sizes.