Cafeteria Plans

A section 125 cafeteria plan contains several employer-provided benefits. Section 125 plans offer tax savings to the employer and employees by reducing employees’ taxable income. With a cafeteria plan, an employer offers employees the option of choosing between a taxable benefit (cash), and various non-taxable, or qualified benefits.

A cafeteria plan must offer a cash benefit and at least one non-taxable benefit.

The non-taxable benefits may include:

• medical and dental coverage for an employee and/or the employee's spouse and children

• a group-term life insurance plan

• contributions under a qualified 401(k) plan (the only type of deferred compensation benefit allowed in a cafeteria plan)

• short and long-term disability insurance

• flexible spending accounts for unreimbursed medical costs and dependent care, and

• health savings accounts.

Benefits that cannot be included are:

• scholarship or fellowship grants

• the value of commuting in a company-provided vehicle

• educational assistance programs

• employer contributions to a Medical Savings Account (MSA)

• long-term care insurance, and

• specific non-taxable fringe benefits (de minimis fringe benefits, working condition fringe benefits, no additional cost services, and employee discounts).

For federal income tax withholding purposes, all non-taxable benefits are considered exempt compensation. The Federal Insurance Contribution Act (FICA) and the Federal Unemployment Tax Act (FUTA) taxability depends on the benefit, and taxability for state withholding and state unemployment varies.

Qualifying Events

Changes to a section 125 cafeteria plan are only made once a year or when a qualifying event occurs.  Qualifying events are life-changing events that the IRS deems and means to enroll, de-enroll, or change a section 125 cafeteria plan. Changes must be consistent with the qualifying event.

These events can include:

• significant change in health coverage of the employee or spouse attributable to the spouse's employment (POP only)
• employee, spouse, or dependent becomes eligible or ineligible for Medicare/Medicaid
• change in residence or work site of employee, spouse, or dependent*
• dependent care cost motivated change or provider change (FSA only)
• change in legal marital status, separation, or divorce
• change in number of dependents (birth, adoption, or death)
• termination or commencement of employment or benefits by the employee's spouse or the employee's dependent
• change in work schedule (full-time to part-time or vice versa)*
• dependent satisfies (or ceases to satisfy) dependent eligibility requirements
• unpaid leave of absence by the employee or the employee's spouse*
• return from unpaid leave of absence by the employee or the employee's spouse

*Allowable only if eligibility is affected.

Refer to the Internal Revenue Code, section 125 for the specific legal language defining section 125 cafeteria plans. For specific questions on cafeteria plan taxability, please refer to your state regulations or consult your accountant or tax professional.