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Many flexible spending accounts have a rule that pretax contributions must be used by a certain date of the year and must not roll over into the following plan year. The IRS announces cost-of-living and other adjustments that impact numerous tax provisions, including cafeteria plans, every year for the following tax year.
The written plan must specifically describe all benefits and establish rules for eligibility and elections. A plan maintained under a collective bargaining agreement doesn't favor highly compensated and key employees. If the plan favors highly compensated employees as to eligibility to participate, contributions, or benefits, the value of taxable benefits they could have selected must be included in their wages.
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The plan may make benefits available to employees, their spouses and dependents. It may also include coverage of former employees, but cannot exist primarily for them.
Employer contributions to the cafeteria plan are usually made pursuant to salary reduction agreements between the employer and the employee in which the employee agrees to contribute a portion of his or her salary on a pre-tax basis to pay for the qualified benefits.
Salary reduction contributions are not actually or constructively received by the participant. Therefore, those contributions are not considered wages for federal income tax purposes. In addition, those sums generally are not subject to FICA and FUTA.
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The usual script of a cafeteria plan starts prior to the beginning of each plan year, when the employees estimate how much they'll spend in out-of-pocket medical expenses and/or dependent care expenses during the course of their plan year.
This amount is then deducted over the course of the plan year from their paychecks before being taxed and is deposited into their flexible spending accounts.
On or after the first day of the plan year, an employee is restricted from changing or revoking the section 125 agreement with respect to the pre-tax premiums until the plan year has ended unless a "change in family status" occurs (as defined under the federal tax code) and the change is consistent with the "change in family status."
The employees pay their out-of-pocket expenses upfront and then submit a claim and documentation to the plan administrator. A reimbursement is then made from their own accounts with pre-taxed dollars and sent to them in the form of checks. |
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| Participating in a cafeteria plan offers the following benefits: |
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- Employee tax savings: saves employees on federal, and most state and local withholding taxes while helping them pay for eligible out-of-pocket expenses.
- Lower taxable income: since funds are placed into this account pre-tax, it reduces the amount of taxable income present on a W-2 later in the year.
- Reduction of employer payroll and tax liabilities: for a business owner, a section 125 plan helps to reduce payroll and tax liabilities, including FICA and FUTA.
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Without a doubt, a section 125 cafeteria plan offers cost-effective benefits plan for companies and can help businesses save money while keeping employees happy, nevertheless, due its complexity and compliance issues, it is best for employers to contact a benefits administration professional who specializes in creating and administering these types of plans.
In future newsletters we will address the different existing options for health accounts, be they health savings accounts (HSA), health reimbursement accounts (HRA), or flexible spending accounts (FSA).
In the meantime, make sure to keep close track of all your benefits throughout the year, so you can enjoy the tax exclusions you are entitled to and avoid any kind of trouble with the IRS. For this, as for all your dealings with taxes and the IRS, please enroll help from a tax professional! |
