5.4 Cafeteria Plans

• Library: Corporations and Partnerships in Virginia (Virginia CLE) (2016 Ed.)

5.4 CAFETERIA PLANS

5.401 In General. A "cafeteria plan" is a written plan under which employees may choose among two or more benefits, including nontaxable benefits, cash, property, or other taxable benefits. ²⁶⁷ The purpose of such a plan, generally, is to facilitate shifting the cost of employer-provided benefits to employees on a tax-favored basis. At the simplest level, the cafeteria plan permits employees to pay the portion of benefits required to be paid by the employee with pretax dollars. This simple arrangement is typically known as a premium conversion arrangement. The advantage to any employer, whether large or small, is that payment of the employee's portion of benefit costs in pretax dollars not only saves the employee income taxes, but also saves employment taxes for both the employer and the employee. At a slightly more complex level, the cafeteria plan allows the employee to select additional benefits and to pay for them with pretax dollars. The additional benefits offered typically include flexible spending accounts, such as a medical reimbursement plan and a dependent care plan. These types of plans are discussed in more detail below. At the most complex level, a cafeteria plan can offer a wide array of benefits including survivor income benefits and vision and dental insurance as optional accident and health benefits and allow employees to buy vacation days in lieu of benefits or to sell vacation days to use their value to purchase higher levels or additional benefits. This degree of complexity generally works only with large employers that have enough employees to be able to offer wide ranges of benefit choices and levels and that have the personnel to handle the administration.

Before electing to pay health insurance premiums for dependent children on a pretax basis under a cafeteria plan, employees should consider the effect of this election on the amount and availability of the earned income credit under I.R.C. § 32. The maximum amount of income that may be earned for a person to qualify for the earned income credit varies from year to year. For tax year 2016, it was $39,296 for a single taxpayer with more than one qualifying child.

HIPAA makes it clear that long-term care insurance, while typically treated as an accident or health plan, is not a qualified benefit under a cafeteria plan. ²⁶⁸ As a result, premiums for this insurance paid by the employee may not be paid on a pretax basis.

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A. Changes in Elections. In order to be a cafeteria plan, a plan must not allow changes in elections under the plan during the coverage period (generally, 12 months) except in certain circumstances. The regulations under I.R.C. § 125 provide that the events where changes may be made are (i) commencement of an FMLA leave period; (ii) entry of a qualified medical child support order; (iii) entitlement to coverage under Medicare or Medicaid; (iv) a significant change in cost or coverage with respect to a benefit option available to the employee, spouse, or dependent; (v) termination of eligibility under other coverage (including COBRA); (vi) change in employment status of the employee, spouse, or dependent; (vii) change in residence of the employee, spouse, or dependent; (viii) change in marital status; birth, death, adoption, or placement for adoption of a child; or (ix) change in dependency status of a dependent. ²⁶⁹ With respect to the last three items, the change in election must be consistent with the change in status. The IRS has published extensive regulations identifying the events for which changes are permitted and the specific changes relating to these events that may be made. ²⁷⁰ In 2014, the IRS issued guidance modifying the cafeteria plan rules with respect to same-sex spouses. ²⁷¹ Before the Supreme Court's holding in United States v. Windsor, ²⁷² employers could not allow employees to elect coverage of same-sex spouses on a pretax basis under a cafeteria plan, although they could permit that coverage on an after-tax basis. The IRS's post-Windsor guidance permits mid-year elections to cover same-sex spouses who were lawfully married to the participant as of the date of the Windsor decision (June 26, 2013). It also permits a mid-year change that corresponds to a participant's change in marital status relating to the participant's same-sex marriage. In addition, the IRS's guidance clarified how pre-Windsor after-tax contribution arrangements would be taxed to the employee.

In 2014, the IRS published guidance to synchronize these regulations with certain changes established by the ACA. ²⁷³ The guidance allows an employee to prospectively revoke coverage in a cafeteria plan that is not a health flex spending account in two circumstances.

First, an employee who experiences a change in status so that the employee does not reasonably expect to work 30 or more hours a week may

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revoke such coverage, even if the employee's status change does not affect his or her eligibility under the plan. The employee's election must correspond to the intended enrollment of the employee and any related individuals who cease coverage due to the revocation in another plan that provides minimum essential health coverage no later than the first day of the second month following the month that includes the date the original coverage is revoked.

Second, an employee may revoke such coverage if the employee is eligible for a special enrollment period (due to loss of coverage or certain family events) to enroll in a qualified health plan through the individual marketplace pursuant to guidance issued by the Department of Health and Human Services or during the marketplace's annual open enrollment period. The employee's revocation must correspond to the intended enrollment of the employee and any related individuals who cease coverage due to the revocation in a qualified health plan through a marketplace for new coverage that is effective beginning no later than the day immediately following the last day of the original coverage that is revoked.

This guidance provides employees with much needed flexibility to revoke coverage elections when an employee's reduction in hours does not affect the employee's eligibility under a plan due to certain requirements in the ACA. In addition, it provides employees with flexibility to purchase coverage on an exchange, even when the end of an employer's plan year does not align with the open enrollment period for the exchange.

In addition to the changes in elections permitted under the I.R.C. § 125 regulations discussed above, HIPAA also requires that a participant (the employee or any dependent) in a group health plan be permitted to enroll in coverage following the occurrence of certain events. ²⁷⁴ To be eligible for these HIPAA "special enrollment rights," the employee (or dependent) must otherwise be eligible to enroll in the benefit package, the employee (or dependent) must have had coverage under another group health plan at the time when coverage was previously offered, and one of the following events has occurred:

• The employee (or dependent) loses eligibility for coverage as a result of legal separation, divorce, cessation of dependent status, death of an employee, termination of employment, reduction in the number of hours of employment;

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• Employer contributions to the employee's (or dependent's) coverage terminate and the coverage is not COBRA continuation coverage; or

• The employee (or dependent) is on COBRA continuation coverage that is exhausted. ²⁷⁵

A plan may require...