A Cafeteria Plan, as defined under Section 125 of the Internal Revenue Code (https://www.irs.gov/pub/irs-drop/rr-02-41.pdf), is a benefits arrangement that allows employees to choose from a variety of pre-tax benefits, tailoring their compensation package to best suit their individual needs. This flexibility not only enhances employee satisfaction but also offers tax advantages to both employers and employees.

Frequently Asked Questions about Cafeteria Plans

What is a Cafeteria Plan?

A Cafeteria Plan is a written plan that allows employees to select from a menu of benefits, including cash or qualified nontaxable benefits, such as health insurance, without adverse tax consequences.
Learn more from the IRS (https://www.irs.gov/pub/irs-drop/rr-02-41.pdf).

What are the advantages of participating in a Cafeteria Plan?

• Tax Savings: Employees can pay for qualified benefits with pre-tax dollars, reducing their taxable income.
• Customization: Employees can tailor their benefits package to meet personal and family needs.
• Employer Benefits: Employers may experience reduced payroll taxes due to lower taxable payroll.

Which benefits can be included in a Cafeteria Plan?

Qualified benefits may include:
✔️ Health and dental insurance premiums
✔️ Flexible Spending Accounts (FSAs)
✔️ Health Savings Accounts (HSAs)
✔️ Group-term life insurance
✔️ Dependent care assistance
✔️ Accident and health benefits
✔️ Adoption assistance
✔️ Certain other qualified benefits

Note: Deferred compensation plans are generally excluded.
See IRS guidelines (https://www.irs.gov/government-entities/federal-state-local-governments/section-125-cafeteria-plans).

Who is eligible to participate in a Cafeteria Plan?

Generally, all employees are eligible to participate. However, plans must undergo nondiscrimination testing to ensure they do not favor highly compensated employees, key employees, or shareholders.
More details from the IRS (https://www.irs.gov/government-entities/federal-state-local-governments/section-125-cafeteria-plans).

Are there any restrictions on Cafeteria Plans?

Yes, certain benefits, such as scholarships, educational assistance, and fringe benefits, cannot be offered through a Cafeteria Plan. Additionally, plans must comply with specific IRS regulations to maintain their tax-advantaged status.
Read IRS restrictions (https://www.irs.gov/pub/irs-pdf/p15b.pdf).

How does a Cafeteria Plan affect my taxes?

Contributions to a Cafeteria Plan are made on a pre-tax basis, reducing your gross income and, consequently, your taxable income. This can lead to significant tax savings on federal income tax, Social Security, and Medicare taxes.

Can I change my benefit selections during the plan year?

Generally, benefit elections are irrevocable for the plan year. However, certain qualifying life events, such as marriage, birth of a child, or loss of other coverage, may allow for mid-year changes.
See IRS rules on changes (https://www.irs.gov/pub/irs-drop/n-14-55.pdf).

What happens to unused funds in my Flexible Spending Account (FSA)?

Unused FSA funds are typically forfeited at the end of the plan year, known as the “use-it-or-lose-it” rule. However, employers may offer:
✔️ A grace period of up to 2.5 months
✔️ A carryover of up to a specified amount to the next plan year
Learn more about FSA rules (https://www.irs.gov/publications/p969).

Are employers required to establish a Cafeteria Plan?

No, establishing a Cafeteria Plan is optional for employers. However, offering such a plan can be a valuable tool for attracting and retaining employees, as well as providing tax benefits to the organization.

What are the compliance requirements for employers?

Employers must ensure the plan:
✅ Is in writing
✅ Complies with IRS regulations
✅ Undergoes annual nondiscrimination testing
✅ Maintains proper documentation
✅ Files necessary reports, such as Form 5500 (https://www.irs.gov/forms-pubs/about-form-5500), if applicable

Final Thoughts

Implementing a Cafeteria Plan can offer substantial benefits to both employers and employees by providing tax savings and flexible benefit options. It’s essential to consult with a tax professional or benefits consultant to ensure compliance with all applicable laws and regulations.