Many small employers have historically shied away from establishing Internal Revenue Code (“Code”) section 125 cafeteria plans due to administrative and logistical issues associated with nondiscrimination testing. Specifically, many small employers’ employee population and benefit utilization makes it extremely difficult to pass the various nondiscrimination testing requirements under the Code. Further, tracking nondiscrimination testing demographics can be time consuming, costly, and just an overall daunting experience. In an attempt to provide small employers with the tax advantages associated with Code section 125 cafeteria plans without the hassle of monitoring nondiscrimination testing compliance, the Patient Protection and Affordable Care Act amended Code section 125 to permit certain eligible small employers to establish a “simple cafeteria plan”. Of interest to employers, a simple cafeteria plan (and many component benefits offered under the simple cafeteria plan) is treated by the Internal Revenue Service (“IRS”) as meeting the applicable nondiscrimination rules associated with cafeteria plans (including Code sections 125, 105(h), 129(d), and 79(d)). Thus, a simple cafeteria plan is a welcomed additional option for certain small employers that do not want to carefully monitor benefit utilization and/or who in the past have had to exclude certain highly compensated individuals from participation.
Code section 125(j) provides guidance related to compliance and administrative issues associated with simple cafeteria plans. Specifically, this Code subsection establishes (1) which employers can sponsor a simple cafeteria plan; (2) which employees must be eligible under a simple cafeteria plan; and (3) what contributions must be provided under a simple cafeteria plan:
- Which Employers Can Establish a Simple Cafeteria Plan? In general, employers who employed an average of 100 or less employees on business days during either of the previous two years may establish a simple cafeteria plan. Special rules exist for newly established employers. Additionally, a “growing employer” rule exists for an employer who had been within the 100 employee threshold when it established the simple cafeteria plan under which such employer will continue to be treated as an eligible employer until the year following the first year in which it employs an average of 200 or more employees on business days.
- Which Employees Must be Eligible? In general, all employees with at least 1,000 hours of service during the previous plan year must be eligible to participate in the plan. However, certain employees may be excluded (e.g., employees who have not attained age 21 before the close of the plan year; employees who have less than one year of service with the employer as of any day during the plan year; certain employees covered by collective bargaining agreements; and certain nonresident aliens working outside of the United States). And, pursuant to general cafeteria plan rules, certain individuals are categorically ineligible to participate (e.g., partners in a partnership, more than 2% S-corporation shareholders, self-employed individuals). Each employee who is eligible to participate must be able to elect any benefit available under the plan (subject to any terms and conditions that apply to all participants).
- Is the Employer Required to Contribute? Qualified employees (i.e., employees who are eligible to participate in the cafeteria plan and are neither key employees under Code section 416(i) nor highly compensated employees under Code section 414(q)) must receive employer contributions in an amount equal to (1) a uniform percentage of not less than 2% of the employer’s compensation for the plan year; or (2) an amount that is not less than the lesser of 6% of the employee’s compensation for the plan year or twice the amount of the employee’s salary reductions. The employer contribution must be provided to each qualified employee, regardless of whether such employee makes any salary reduction contributions under the plan. Additional rules apply with respect to matching contributions on behalf of highly compensated employees and key employees.
To date, the IRS has not issued regulations or other guidance related to simple cafeteria plans beyond Code section 125(j). As such, to date a fair amount of flexibility exists with respect to how employers can structure their simple cafeteria plans. Nonetheless, Code section 125 cafeteria plan requirements are specific and require detailed documentation and diligence. Employers contemplating establishing a simple cafeteria plan should coordinate with their legal counsel to ensure all applicable requirements are met.
This alert serves as a general summary of lengthy and comprehensive new provisions of the Internal Revenue Code. It does not constitute legal guidance. Please contact us with any specific questions.
Elizabeth H. Latchana specializes in employee health and welfare benefits. Recognized for her outstanding legal work, in both 2018 and 2015, Beth was selected as “Lawyer of the Year” in Lansing for Employee Benefits (ERISA) Law by Best Lawyers, and in 2017 as one of the Top 30 “Women in the Law” by Michigan Lawyers Weekly. Contact her for more information on this reminder or other matters at 517.377.0826 or firstname.lastname@example.org.