Virtually every employer that offers group health coverage at work also sponsors a cafeteria plan. Cafeteria plans provide significant tax advantages by allowing employees to pay for health coverage, flexible spending accounts, and other options from their pay before taxes are deducted. By making pretax contributions, the employee saves money from reduced income taxes and both the employee and employer save from lower payroll taxes. In exchange for the tax advantages, however, cafeteria plans must comply with requirements under § 125 of the Internal Revenue Code, including nondiscrimination testing to ensure the plan does not disproportionately favor highly-compensated employees.
Did you know that small and midsize employers qualify for a special type of cafeteria plan that eliminates the need for nondiscrimination testing? It’s simple — in fact it is called a Simple Cafeteria Plan. Several years ago, Congress created a simpler plan for smaller employers that meet conditions for eligibility, participation, and employer contributions. As long as those requirements are met, the Simple Cafeteria Plan is automatically deemed nondiscriminatory under § 125.
Only smaller employers are eligible to sponsor a Simple Cafeteria Plan. That means the employer has had an average of 100 or fewer employees during either of the two preceding years. If the employer was not in business throughout the preceding year, the employer is eligible if it reasonably expects to employ an average of 100 or fewer employees in the current year.
Also, if a Simple Cafeteria Plan is established in a year in which an average of 100 or fewer employees are employed, the employer remains eligible for subsequent years, as long as it does not employ an average of 200 or more employees.
The Simple Cafeteria Plan generally must be offered to all employees who had at least 1,000 hours of service in the preceding plan year. The employer may, however, design its plan to exclude employees who:
- Are under age 21 before the close of the plan year;
- Have less than one year of service as of any day during the plan year;
- Are covered under a collective bargaining agreement; or
- Are nonresident aliens working outside the United States whose income did not come from a U.S. source.
Employees who are eligible to participate may elect any of the benefits available under the plan.
The last requirement for a Simple Cafeteria Plan is the employer contribution. Specifically, the employer must provide qualified benefits on behalf of each eligible employee in an amount equal to:
- A uniform percentage (not less than 2 percent) of the employee’s compensation for the plan year; or
- An amount which is at least 6 percent of the employee’s compensation for the plan year or twice the amount of the salary reduction contributions of each qualified employee, whichever is less.
If the contribution requirement is met using option two, the rate of contribution to any salary reduction contribution of a highly-compensated or key employee cannot be greater than the rate of contribution to any other employee.
CMS usually is looking for information on persons for whom Medicare has already paid claims, which may have been several years ago. Receiving an inquiry now regarding claims paid three years ago is not unusual.
The § 125 rules that require nondiscrimination testing for a traditional cafeteria plan can be challenging for some employers. In particular, smaller employers often complain that the tests may limit the ability of their highly-compensated employees to benefit from dependent care spending accounts.
For small and midsize employers, a Simple Cafeteria Plan may be a viable alternative. By meeting specific criteria for eligibility, participation, and employer contributions, the plan automatically qualifies as nondiscriminatory without the need for complex testing.
Employers and their advisors can learn more about Simple Cafeteria Plans in IRS Publication 15-B.