What is a Cafeteria Plan?
A Cafeteria Plan (which includes Premium Only Plans and Flexible Spending Accounts) is an employee benefits program designed to take advantage of Section 125 of the Internal Revenue Code. A Cafeteria Plan allows employees to pay for certain qualified expenses on a pre-tax basis, thereby reducing their taxable pay and increasing their take-home pay. Employees who are eligible for the employer’s group health plan can enroll in a FSA plan even if they have not enrolled in a health plan(s).
Funds set aside in Flexible Spending Accounts (FSAs) are not subject to federal, state, or Social Security taxes. The employee and the employer participate in the tax savings. On average, employees save from $.25 to $.40 for each dollar they contribute to the FSA. The savings is based on the employee’s tax bracket.
What benefits are included under a Cafeteria Plan?
Premium Only Plan (POP)
Employers may deduct the employee's portion of the company-sponsored insurance premium directly from the employee's paycheck before taxes are deducted. When allowing employees to pay for benefits on a pre-tax basis, rules apply regarding employee enrollment changes. Employee can only make mid-year changes if they have a qualified event. Examples of a qualified event include: marriage, divorce, birth of a child, adoption of a child, loss of coverage by a spouse, a spouse open enrollment, etc.
Flexible Spending Account (FSA)
In an FSA, employees may set aside on a pre-tax basis a pre-established amount of money per plan year. The employee can use the funds in the FSA to pay for eligible health care expenses, dependent care, or transportation expenses.
What employers who are considering offering an FSA need to know:
Plan Administration/Employer Advantages
Employers will typically hire a Third Party Administrator (TPA) to handle the administration of the FSA Program. TPA’s commonly will charge a per employee per month fee based on the employees participating in the FSA program. There may also be minimum monthly fees, a set up charge, a charge for the plan documents and plan testing. Because a FSA Plan offers a tax-advantage, employers experience tax savings from reduced FICA, FUTA, SUTA, and Workers' Compensation taxes on participating employees. These tax savings usually reduce or eliminate the various costs associated with offering the plan.
Employee Payroll Deductions
An employee who participates in the FSA must place a certain dollar amount into the FSA each year. The employee’s election is automatically deducted from their paycheck (for that amount divided by the number of payroll periods). For example, an employee is paid 24 times a year, and elects to put $480 in the FSA thus, $20 is deducted pre-tax from each paycheck and is held in an account to be reimbursed upon request. Many employers allow the use of a debit card (issued by the TPA) for drawing funds from their FSA. While not all providers accept a debit card, those that do make it more convenient for the employee to use the plan.
Plan Year/ Extended Use of Funds
The plan year is 365 days and generally begins on the first of a month. Many employers design their flexible spending plan to run on the same plan year as their insurance program even if they are not calendar year. The reason is that employees need to know what their out of pocket costs will be for the upcoming plan year to determine how much they should set aside in the health care FSA.
Following the end of the plan year employees have access to funds in a few ways. Many employees fail to participate in a FSA plan as they are worried about the “use it or lose it” rule. It is important for an employer to educate their employees on which method they have elected allowing for employees to have use of their unused dollars.
One method that allows employees to use funds from the prior plan year is a grace period. Employees have up to 75 days after the end of the official plan year during which they may use funds remaining at the end of the plan year. For example, if the plan year runs from July 1 through June 30, the grace period for that plan may continue up to September 15. If an employee incurs an expense after June 30 but before September 15, they can utilize the remaining funds from the previous plan year.
Another method allowing for the use of unused funds is a run out period. In addition to the 75 day grace period, plan participants can have an additional 90-day run-out period in which they submit requests for reimbursement for expenses incurred during the dates of service within the plan year and grace period.
On October 31, 2013, a new carryover or rollover provision was implemented allowing employees to rollover up to $500 of unused health care FSA funds from one plan year to the next. The rollover feature allows the employee flexibility in deciding how much money to set aside in their health care FSA each year knowing that they won’t lose up to $500 of unused dollars.
The rollover provision does not apply to Dependent Care FSA Plans.
If an employer includes a rollover feature in their FSA Plan, they may not also allow for the use of a grace period for unused dollars; it must be one or the other.
Under a Health Care FSA, an employee must be allowed access to their full annual election even though they have only contributed a portion of their total election. This is a great benefit for employees however it is a risk for employers.
Here is an example:
If an employee sets aside $1,000 with the new plan year starting January 1st and then on January 3rd, has outpatient surgery getting reimbursed $1,000 due to their out of pocket expenses and the employee then terminates employment on January 5th, the employer must fund the negative balance in the employee’s account. Once an employer has a FSA in place for a few years this risk is typically offset by other employees who do not spend all their FSA funds. These unused dollars go into a forfeiture account that offsets future employee negative balance accounts and can be used to pay for plan administration.
This provision only applies to a Health Care FSA, not a Dependent Care FSA as an employee only has access to the balance in their Dependent Care FSA account.
Section 125 of the Internal Revenue Code requires that Cafeteria Plans be offered on a nondiscriminatory basis. To ensure compliance, the Internal Revenue Code sets forth testing requirements that must be satisfied. These testing requirements are in place to make certain that Cafeteria Plan benefits are available to all eligible employees under the same terms, and that the Plan does not favor highly compensated employees, officers, and owners.
The nondiscrimination testing must be done including employee elections as well as any employer contributions.
Employee and Employer Contributions for 2017
Health Care FSA - $2,600
Dependent Care FSA - $2,500 if employee is married and files a separate tax return; $5,000 if employee is married and files a joint tax return or files as single, head of household; if both parents have access to a FSA offered through their employer the maximum they both can set aside is $5,000 on a combined basis.
Transportation FSA – Commuter highway vehicle and transit-pass - $255 per month; Qualified parking - $255 per month
Employers may contribute towards the employee’s FSA plan. The maximum employer contribution for a Health Care FSA is also $2,600. Employees can elect a lower Heath Care FSA contribution than the employer’s contribution. If the employer’s contribution is more than the employee’s contribution and the employee sets aside more than $500, the employer can only match up to the employee’s contribution. If the employee sets aside less than $500, the employer can match up to $500.
Employer’s may also contribute towards the Dependent Care FSA. The combined employer and employee contributions cannot exceed the annual IRS limits.
Common FSA Plans
Health Care FSA Plan
The most common FSA is the Health Care reimbursement plan as it is used to pay for common expenses an employee and their eligible dependents incur for qualified medical, dental and vision services. As of January 1, 2011, over the counter medications can only covered when prescribed by a physician.
What types medical expenses are allowed under the Health Care FSA?
Qualified medical expenses are defined by the IRS in Publication 502. Medical expenses are the costs of diagnosis, cure, mitigation, treatment, or prevention of disease, and the costs for treatments affecting any part or function of the body. These expenses include payments for legal medical services rendered by physicians, surgeons, dentists, and other medical practitioners. They include the costs of equipment, supplies, and diagnostic devices needed for these purposes. Medical care expenses must be primarily to alleviate or prevent a physical or mental defect or illness. They don't include expenses that are merely beneficial to general health, such as vitamins.
Non-prescription medicines (other than insulin) aren’t considered qualified medical expenses for FSApurposes. A medicine or drug will be a qualified medical expense for FSA purposes only if the medicine or drug:
- Requires a prescription
- An over-the-counter medicine or drug that has been prescribed by a doctor
- Is insulin
Who is covered under a Health Care FSA?
Qualified medical expenses are those incurred by the following persons:
- You and your spouse.
- All dependents you claim on your tax return.
- Your child under age 27 at the end of your tax year.
- Any person you could have claimed as a dependent on your return except if:
- The person filed a joint return,
- The person had gross income of $4,050 or more, or
- You, or your spouse if filing jointly, could be claimed as a dependent on someone else's 2016 return.
Dependant Care FSA Plan
The Dependent Care FSA allows the employee to deduct pre-tax dollars to pay for work related dependent care expenses. Typically, the Dependent Care FSA is used for child care for children under the age of 13, it can also be used for children of any age who are physically or mentally incapable of taking care of them self or a disabled spouse. The person or persons who’s care expenses are through the Dependent Care FSA must be claimed as a dependent on the employee’s federal tax return. For senior citizen dependents who live with the employee such as a parent or grandparent services for adult day care can be set aside in a Dependent Care FSA. An adult may qualify as a dependent if the employee is providing more than half of the individual’s support for the year. The dependent must live with the employee and incapable of taking care of themselves.
The day care provider does not have to be licensed however they must provide the employee with their Tax Identification number or Social Security Number for use in filing on the employee’s taxes.
Children attending day camp can be considered eligible if it allows the employee and their spouse if married to work. Overnight camps typically are excluded.
Commuter Expense FSA Plan
Employees may set aside pre-tax dollars for qualified commuter expenses. This FSA is under Section 132 of the Internal Revenue Code. Employees can contribute to the Commuter Expense FSA for parking costs, mass transit and van pooling expenses.