Proposed cafeteria plan regulations.

On April 21, 2008, Tax Executives Institute submitted comments on the proposed cafeteria plan regulations issued under section 125 of the Internal Revenue Code. The comments were prepared under the aegis of TEI's Federal Tax Committee, whose chair is Carita Twinem of the Briggs & Stratton Corporation. Also contributing to the development of TEI's comments were Robert J. Birch of Wellmark, Inc., Chair of the Federal Tax Subcommittee on Employee Benefits and Payroll Taxes, Nancy C. Farahmand of JC Penney Company, Inc., and Michael J. Nesbitt of Paychex, Inc., and Beth P. Klimczak of Briggs & Stratton Corporation.

On August 6, 2007, the U.S. Department of Treasury and the Internal Revenue Service issued proposed regulations to provide guidance under section 125 of the Internal Revenue Code relating to cafeteria plans. (1) The proposed regulations were published in the August 6, 2007, issue of the Federal Register (72 F.R. 43937) and the September 24, 2007, issue of the Internal Revenue Bulletin (2007-39 I.R.B. 681). A hearing on the proposed regulations was held on November 15, 2007.

Background

Tax Executives Institute is the preeminent global association of business tax executives with 7,000 members representing 3,200 of the leading corporations in the United States, Canada, Europe, and Asia. TEl represents a cross-section of the business community, and is dedicated to developing and effectively implementing sound tax policy, to promoting the uniform and equitable enforcement of the tax laws, and to reducing the cost and burden of administration and compliance to the benefit of taxpayers and government alike. As a professional association, TEl is firmly committed to maintaining a tax system that works--one that is administrable and with which taxpayers can comply in a cost-efficient manner.

Members of TEI are responsible for managing the tax affairs of their companies and must contend daily with the provisions of the tax law relating to the operation of business enterprises. We believe that the diversity and professional training of our members enable us to bring a balanced and practical perspective to the proposed regulations.

Executive Summary

A summary of TEI's recommended changes to the proposed section 125 cafeteria plan regulations is, as follows:

* Eliminate the statement in Prop. Reg. [section] 1.125-1(b)(1) that section 125 is the exclusive means of avoiding the constructive receipt doctrine when electing between taxable and nontaxable benefits.

* Ameliorate the harsh disqualification rule for operational plan violations.

* Avoid treating all cafeteria plan benefits as taxable to the participants where operational violations involve only a discrete part of a plan.

* Clarify when benefits "defer compensation" or operate to "defer compensation"; revise the timing for cash outs of accrued, unused leave.

* Permit certain election changes after the beginning of a plan year.

* Clarify the nondiscrimination rules.

* Establish a nationwide inventory information approval system reporting website for medical suppliers or defer the proposed effective date of Prop. Reg. [section] 1.125-6(h) in respect of debit card arrangements to plan years beginning January 1, 2010.

Section 125 Is Not the "Exclusive" Means of Avoiding the Constructive Receipt Doctrine

Prop. Reg. [section] 1.125-1(b)(1) states that "section 125 is the exclusive means by which an employer can offer employees an election between taxable and nontaxable benefits without the election itself resulting in gross income to the employee." (2) (Emphasis added.) TEI believes this statement is overbroad and should be removed from the regulations. Despite the recitation of selective portions of the legislative history of section 125 in the preamble, section 125 only applies to elections between cash and qualified benefits; it does not apply to elections between cash and nonqualified benefits, including "benefits" or compensation that might properly be understood as employee working conditions or reimbursable expenses. Hence, the statement in the regulations potentially distends the doctrine of constructive receipt by seeking to apply section 125 to circumstances far beyond the statute and the facts and circumstances to which the constructive receipt doctrine has historically been applied. Specifically, employment and pre-employment contract negotiations frequently encompass not only cash compensation, equity awards, and nontaxable benefits but also such matters as:

* departmental budgets (including the amount, manner, and scope of customer entertainment expenses; professional training for the executive and staff; organizational dues; and other forms of reimbursable employee expenses);

* administrative support (including salaries or a bonus pool for administrative support staff), office furnishings and decorations befitting the position (including computers or other electronic equipment); and

* allowances for temporary long-distance commuting or moving expenses.

In these negotiations, an employee or prospective employee often gives up rights to forms of or additional amounts of taxable compensation in exchange for potentially nontaxable compensation, benefits, reimbursable expenses, or guarantees relating to future working conditions. The constructive receipt doctrine has not previously reached...