Transcript Slide 1
This Employer Webinar Series program is presented by Spencer Fane Britt & Browne LLP in conjunction with United Benefit Advisors in conjunction with United Benefit Advisors Kansas City = Omaha = Overland Park St. Louis = Jefferson City
www.spencerfane.com
www.UBAbenefits.com
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The Basics of Cafeteria Plans
Presented by
Kenneth A. Mason Lawrence Jenab
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Presenters
Ken Mason [email protected]
913-327-5138 Larry Jenab [email protected]
913-327-5125
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What Is a Cafeteria Plan?
Choice between taxable benefits (e.g., cash) and non-taxable benefits (
e.g.
, health care coverage) Section 125 is the exclusive means by which employer can offer a choice without the choice itself resulting in taxable income to the employee (under “constructive receipt” doctrine) A plan offering a choice between only taxable benefits (cash or paid time off), or only non taxable benefits (
e.g.
, a “flex plan”) is not a cafeteria plan
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Qualified Benefits
Employer-provided health coverage Health flexible spending account (“FSA”) Dependent care FSA (“DCAP”) Group-term life insurance AD&D insurance STD and LTD insurance Adoption assistance HSA contributions 401(k) contributions PTO
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Impermissible (but Tax-Favored) Benefits
Scholarships Educational assistance benefits Dependent life insurance Long-term care insurance Fringe benefits 403(b) deferrals Heath reimbursement arrangement (“HRA”) Medical savings account (“Archer MSA”)
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Eligibility
Current employees Former employees (so long as plan is not maintained predominantly for them) But not: Self-employed individuals Sole proprietors Partners Directors 2% shareholders of S-corporations
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Written Plan Document
Must have a written plan document Program must be operated in accordance with plan’s terms Plan must be adopted and effective on or before first day of plan year Any amendments must be made through formal written instrument
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No Deferral of Compensation
Prohibition on deferred compensation does not apply to the following: 401(k) contributions HSA contributions Grace period (up to 2 ½-months after end of plan year) LTD policy Advance payments for orthodontia Salary reduction at end of one year to pay premiums for beginning of next year
Value to Employees
Advantages for employees: No federal income tax No FICA or Medicare tax Generally, no state or city tax Allows choice among benefits (or cash) Increased take-home pay (vs. after-tax payment) Disadvantages for employees: Irrevocable elections “Use-it-or-lose-it” rule Possibly lower Social Security benefits Copyright 2010
Value to Employers
Advantages for employers: No FICA or Medicare tax Cushion blow of premium increases (if cafeteria plan is introduced at the same time) Non-comparable employer HSA contributions Disadvantages for employers: Set-up and administration costs “Uniform coverage” rule (under health FSAs) Copyright 2010
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IRS Guidance
Final Regulations: 1.125-3: Effect of FMLA leave 1.125-4: Permitted Election Changes Proposed Regulations: 1.125-1: General Rules 1.125-2: Special Election Rules 1.125-5: Flexible Spending Accounts 1.125-6: Claim Substantiation Rules 1.125-7: Nondiscrimination Rules
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IRS Guidance
Proposed Regulations were issued in 2007, incorporating decades of sporadic guidance Expected to be finalized at any moment May be relied upon in the interim
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Election Rules
General Rule
: Elections must be made – and irrevocable – before beginning of coverage period (generally, 12 months) Several exceptions specified in IRS regulations Exceptions apply only if also set forth in plan document
Exception: Change in Status Event
Change in status events E.g. -- Birth, adoption, marriage, divorce, leave of absence, strike, lockout, change of worksite Election change must be “consistent with” change in status Limits who may add or drop coverage Also requires timely request to change (though no specific deadline) Copyright 2010
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Exception: Special Enrollment
HIPAA special enrollment events Substantial overlap with status changes Two new events under “CHIPRA”: Loss of eligibility for CHIP or Medicaid Entitlement to premium subsidy under either program May allow even unaffected dependents to be enrolled at same time (i.e., no “consistency” requirement) Specific timeframes for enrollment Generally must request change within 30 days 60 days for CHIPRA events
Exceptions: Cost or Coverage Changes
Cost changes If “insignificant,” may automatically adjust pre tax premiums If “significant,” may allow election change Note: Not applicable to FSAs Coverage changes If “significant,” may allow move to other option If change amounts to “loss of coverage,” may allow revocation of election Note: Not applicable to FSAs Copyright 2010
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Example
Employer sponsors health plan with HMO and PPO options, along with an FSA. PPO has $500 annual deductible.
Employer amends PPO mid-year to raise deductible to $2000.
Employees in PPO option may elect to change to HMO option.
But may
not
drop coverage entirely, because not a “loss of coverage.” And may
not
modify FSA elections, even though desirable to cover higher deductible.
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Exception: Court Order
May allow employee to add dependent child or foster child if employee is ordered to cover child May also allow employee to drop child from coverage if other parent is ordered to cover child (and in fact does so)
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Exceptions: Medicare or Medicaid
Employee may be allowed to drop coverage for self or dependent upon becoming entitled to Medicare or Medicaid Similarly, employee or dependent who loses Medicare or Medicaid coverage may be allowed to enroll in employer plan
Exceptions: 401(k) or HSA
If
401(k)
contributions are made through a cafeteria plan (not recommended), 401(k) election change rules apply to that benefit If
HSA
contributions are made through a cafeteria plan, employees
must
be allowed to change their HSA elections monthly In neither case, however, may these election changes affect elections in effect with respect to other benefits (other than cash) Copyright 2010
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Other Enrollment Rules
“Negative” elections are permitted May be “automatic” -- if enrolled in health plan, premiums must be pre-tax May be “default” – if enrolled in health plan, premiums will be pre-tax, unless employee elects after-tax, instead May be “evergreen” -- renewed from year to year unless changed (less common with FSAs, though also permissible) New hires may be allowed to make initial elections within 30 days, retroactive to date of hire (although all pre-tax amounts must be taken from future pay) Electronic elections are specifically authorized
Nondiscrimination: HCEs
Cafeteria plans may not discriminate in favor of “highly compensated individuals” as to eligibility, contributions, or benefits “Highly compensated individuals” include Officers, 5% shareholders, and Employees earning at least the HCE amount (currently, $110,000) in the current or prior year Regulations incorporate certain Section 410(b) rules (applicable to retirement plans) Copyright 2010
Nondiscrimination: Key Employees
“Key employees” may not receive more than 25% of the plan’s total non-taxable benefits “Key Employees” include 5% shareholders, 1% shareholders earning more than $150,000, and officers earning more than $160,000 Particularly problematic for owners of small employers Copyright 2010
Other Nondiscrimination Rules
“Safe harbor” rule for premium-only plans (need only satisfy eligibility nondiscrimination rule, regardless of actual utilization) Safe harbor for health benefits -- but probably too complicated to use All tests are to be conducted on last day of plan year Copyright 2010
Effect of Discrimination
Copyright 2010 Under a discriminatory cafeteria plan, highly compensated individuals or key employees (as applicable) are taxed on the maximum taxable benefit they could have elected to receive Generally, this will be their full salary, denying them any tax exclusion for health or other benefits
Flexible Spending Accounts
Health FSAs – may reimburse medical expenses, but not insurance premiums Dependent Care Assistance FSAs – may reimburse dependent care expenses (for which no credit is claimed) Adoption Assistance FSAs – may reimburse adoption expenses (for which no credit is claimed) Copyright 2010
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Special FSA Rules
All types of FSAs are subject to “use-it or-lose it” rule, although Dependent care and adoption assistance FSAs may allow for “spend-down,” and Any FSA may allow for 2 ½-month “grace period” Health FSAs are subject to “uniform coverage” rule All FSAs are subject to substantiation requirements
FMLA Leave Alternatives
Copyright 2010 Employees on FMLA leave must be allowed to continue health coverage at active-employee premium And employees on unpaid FMLA leave must be allowed to revoke coverage (or receive it at employer’s cost, subject to employer’s later recapture of premiums) Employer may waive employee premium payments while on unpaid leave (on a nondiscriminatory basis)
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FMLA Leave Alternatives
Alternatively, employer may choose to allow employee premium payments under one of three options: “Prepay” (generally pre-tax) “Pay-as-you-go” (generally after-tax, unless employee receives vacation or sick pay while on leave) “Catch-up” (generally pre-tax)
Special HSA Considerations
Copyright 2010 Payroll deduction HSA contributions may be made on a pre-tax basis only through a cafeteria plan Although employees may claim a deduction for after-tax contributions, those contributions would be subject to FICA tax This deduction is not subject to the 7.5% (soon to be 10%) AGI threshold HSA election changes must be allowed on monthly basis (though they cannot affect other elections) Exception to prohibition on deferred compensation (i.e., even though HSA account balances may be carried from year to year, and may be used to pay medical premiums)
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Common Mistakes
Failure to have a plan document Allowing impermissible mid-year election changes (especially for FSAs) Violating the nondiscrimination rules (especially by small employers with owner or key employees) Not allowing monthly HSA elections
Health Care Reform: FSAs, HSAs, HRAs
New restrictions on reimbursements from FSAs, HSAs, and HRAs No reimbursements for OTC drugs (other than insulin) unless prescribed by a physician Effective in 2011 New limit on FSA contributions Annual salary-deferral limit of $2,500 (indexed for inflation) Effective in 2013 Increased tax on nonqualified HSA distributions Tax increases from 10% to 20% For Archer MSAs, tax increases from 15% to 20% Effective in 2011 Copyright 2010
Reform: Safe Harbor for “Simple” Plans
“Simple” cafeteria plans deemed to satisfy: The cafeteria-plan nondiscrimination rules; and The nondiscrimination rules for certain component benefits, such as: Group-term life insurance Self-insured medical coverage Dependent care assistance To be eligible, employer must: Have employed average of 100 or fewer employees during past two years Make minimum non-elective contribution for each eligible employee Available in 2011 Copyright 2010
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Reform: Health Care Exchanges
Affordable Care Act creates state clearinghouses (“exchanges”) for qualified health plans General rule: qualified health plans cannot be offered through a cafeteria plan Exception: certain small employers can offer employees the opportunity to enroll in a qualified health plan
through
an exchange
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Questions and Answers
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