A cafeteria plan is a conduit through which your employer can offer you the choice of cash or tax-preferred benefits. Employers have a lot of discretion in how they design their particular cafeteria plan, so the choice of benefits in each plan will vary by employer. As an employee benefits plan, there are tax benefits for both employers and employees alike.
What is a Cafeteria Plan?
Section 125 of the Internal Revenue Code sets forth the rules for cafeteria plans. These are plans that must be contained in a written document and the participants of the plan must be employees of the employer sponsoring the cafeteria plan. The participants choose between two or more benefits consisting of taxable benefits, cash and non-taxable qualified benefits.
What Types of Benefits Can Be in a Cafeteria Plan?
The Internal Revenue Code provides that only “qualified benefits” may be offered through a cafeteria plan. Qualified benefits are defined to include health and dental plans that cover only the participant as well as his or her spouse and dependents. Dependent care assistance programs are also allowed to be offered as part of a cafeteria plan. Health savings accounts and flexible spending accounts are qualified benefits. Long-term disability and accidental death and dismemberment insurance are also permitted to be part of a cafeteria plan. Benefits such as educational assistance, health reimbursement arrangements, long-term care or scholarships are not allowed to be a part of cafeteria plans.
Participant's Tax Treatment in a Cafeteria Plan
Depending on how the employer has structured the cafeteria plan, employees may reduce their salaries on a pre-tax basis for any contributions for selections in the cafeteria plan. For example, a participant may elect to participate in a flexible spending arrangement for health care. This could be funded through pre-tax salary reduction. Alternatively, some employers establish a system with which participants can use employer contributions to pay for the non-taxable benefits offered through the cafeteria plan. These contributions will not be taxable income to the employee. Employees cannot claim deductions for their participation in a cafeteria plan, but participation will carry tax benefits, such as reducing taxable income.
Employer's Tax Treatment in a Cafeteria Plan
An employer receives substantial tax savings by sponsoring a cafeteria plan. It provides for savings in terms of payroll taxes. It may save the employer state and local taxes, such as unemployment or workers’ compensation, depending on the state or locality. Additionally, employers can deduct the contributions to a cafeteria plan made on behalf of employees as an ordinary and necessary business expense.