This is the second in a 2-part series on cafeteria plans. Click here to go back to Part 1.
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What are the Special Rules for Premium Conversion Plans?
A premium conversion cafeteria plan (POP) — but not a health FSA — is one that offers an election between cash and payment of the employee share of the premium for employer-provided health insurance. Health insurance premium conversion cafeteria plans meet the regular cafeteria plan eligibility nondiscrimination rules if they meet a safe harbor test and pass a safe harbor/unsafe harbor facts-and-circumstances test. Examples of situations that meet or fail this test include the following:
Example (1). Same qualified benefit for same salary reduction amount. Employer A has one employer-provided accident and health insurance plan. The cost to participants electing the accident and health plan is $10,000 per year for single coverage. All employees have the same opportunity to purchase the plan and reduce their salaries by $10,000. The cafeteria plan satisfies the eligibility test.
Example (2). Same qualified benefit for unequal salary reduction amounts. Same facts as Example 1 except the cafeteria plan offers nonhighly compensated employees (NHCEs) the election to reduce their salaries by $10,000 to pay premiums for single coverage. The cafeteria plan provides an $8,000 employer flex-credit to highly compensated employees (HCEs) to pay a portion of the premium, and it provides an election to reduce their salaries by $2,000 to pay the balance of the premium. The cafeteria plan fails the eligibility test because the employer contribution – the flex credit – is given solely to HCEs.
Example (3). Accident and health plans of unequal value. Employer B’s cafeteria plan offers two employer-provided accident and health insurance plans: Plan X, available only to HCEs, is a low-deductible plan. Plan Y, available only to NHCEs, is a high-deductible plan (as defined in Code Section 223(c)(2)). The annual premium for single coverage under Plan X is $15,000 per year, and it is $8,000 per year for Plan Y. Employer B’s cafeteria plan provides that HCEs may elect salary reduction of $15,000 for coverage under Plan X, and that NHCEs may elect salary reduction of $8,000 for coverage under Plan Y. The cafeteria plan fails the eligibility test.
Example (4). Accident and health plans of unequal value for unequal salary reduction amounts. Same facts as Example 3, except that the amount of salary reduction for HCEs to elect Plan X is $8,000. The cafeteria plan also fails the eligibility test.
Can Business Owners Participate in a Simple Cafeteria Plan?
When a business wants to avoid the 25 percent concentration test and contribute for owner-employees, it is likely that only a regular C corporation can do so because only these shareholder-employees are “employees” for income tax purposes. Sole proprietors, more-than-2-percent S corporation shareholders, and partners (including members of LLCs taxed as partnerships) are not employees for income tax purposes. Rather, they are “self-employed” individuals.
Which Employers Can Sponsor a Simple Cafeteria Plan?
In order to establish and maintain a simple cafeteria plan, an employer must qualify as an eligible employer.
An “eligible employer” is one that employed an average of 100 or fewer employees on business days during either of the two preceding years. For this purpose, a year may only be taken into account if the employer was in existence throughout that year. The Code’s simple cafeteria plan provisions do not define the term “year” for the eligible employer definition. Pending IRS guidance, it seems reasonable to use the plan year selected by the employer as the plan’s measuring period. If an employer was not in existence throughout the preceding year, the eligible employer determination is based on the average number of employees that it is reasonably expected such employer will employ on business days in the current year.
If an eligible employer’s workforce continues to grow, it can remain eligible in subsequent years until the employer employs an average of 200 or more employees on business days during any year preceding any such subsequent year.
If an employer has 100 or fewer employees in the current year but more than 100 employees in either of the two preceding years, the employer cannot adopt a simple cafeteria plan for the current year but will be able to do so in the succeeding year. Leased employees within the meaning of Code Sections 414(n) and (o) are counted as employees. However, the Code is silent as to whether an employer can disregard (or count on a full-time equivalent basis) part-time, temporary, or seasonal employees when determining whether it is an eligible employer. Pending guidance, the conservative approach is to count all employees when making an eligible employer determination.
There is no lower limit on the size of the employer. Additionally, an employer whose only employees are prohibited group members (key employees or HCEs), or with only one owner-employee, could qualify as an eligible employer. However, the prohibition against sole proprietors, partners, and more-than-2 percent shareholders in a Subchapter S Corporation participating in a cafeteria plan applies, so, in general, only owner (shareholder)-employees of C corporations can participate in a simple cafeteria plan. Moreover, it is not clear whether such an employer could meet the required employer contributions test.
What Happens when an Employer with a Simple Cafeteria Plan Ceases to Qualify to Sponsor Such a Plan?
Employers with simple cafeteria plans will cease to qualify as eligible employers as their workforces expand beyond 200 employees. Thus, employers that maintain simple cafeteria plans must monitor their status as eligible employers. If an employer ceases to be an eligible employer, the regular concentration and nondiscrimination tests will apply. Employers that cease to qualify as eligible employers will need to determine whether to amend or discontinue their cafeteria plan.
What Aggregation Rules Apply in Defining an Employer?
The employer aggregation rules under Code Section 52 and Code Section 414 (controlled and affiliated service groups) generally apply for purposes of determining an eligible employer. Additionally, an employer includes a “predecessor employer,” but the term is undefined.
Who are “Qualified Employees” that Must be Eligible to Participate in a Simple Cafeteria Plan?
For purposes of a simple cafeteria plan, “qualified employees” are all non-excludable employees who had at least 1,000 hours of service during the preceding plan year, except a highly compensated employee under Code Section 414(q) or key employee under Code Section 416(i) and who is eligible to participate in the plan.
This definition of qualified employee is relevant only to the two alternative minimum contribution requirements, and to highly compensated employees (HCEs) and key employees. HCEs and key employees may participate like everyone else so long as they are “employees” and do not receive disproportionate employer nonelective or matching contributions. Comparable contributions must be made for all eligible employees.
Code Section 414(q) defines an HCE as an employee who:
- was a more-than-5 percent owner of the employer at any time during the current or preceding plan year, or
- for the preceding plan year, had compensation in excess of a specified dollar threshold ($115,000 for 2012).
- If elected by the employer, an HCE may also be an employee in the “top-paid group” (generally constituting the top 20 percent ranked by compensation) of employees
Code Section 416 defines a key employee as an employee who, during the plan year, was:
- an officer of the employer with annual compensation in excess of a specified dollar threshold ($160,000 for 2010),
- a more-than-5-percent owner of the employer, or
- a more-than-1-percent owner of the employer with annual compensation in excess of $150,000.
Which Employees are Excludable Employees?
Excludable employees (employees who need not be allowed to participate) are those who:
- have not attained age 21 (or a younger age provided in the plan) before the end of the plan year;
- have less than 1000 hours of service in the prior plan year;
- have less than one year of service as of any day during the plan year;
- are covered under a collective bargaining agreement; or
- are nonresident aliens working outside the United States.
An employer may have a shorter age and service requirement but only if such shorter service or younger age applies to all employees.
Employees who worked 1,000 hours in a previous plan year but who do not have a year of service in the current plan year can be excluded for the current year. However, since the rule is that they can be excluded if they do not have a year of service on any day in the year, they may have 1,000 hours if they go from full-time to part-time during the current plan year. This is an important point when the employee’s salary is less than the health benefits. Employees should be entitled to the entire maximum benefit if elected, even if greater than their compensation in order to safeguard simple status for the cafeteria plan.
What is the Benefit Nondiscrimination Requirement?
Each participating employee must be able to elect any benefit under the plan under the same terms and conditions as all other participants. Again, if the special requirements of a specific benefit apply, such as adoption assistance, they must be met as well.
What is the Employer Minimum Contribution Requirement?
There are two alternative employer contribution requirements. Employer contributions to a simple cafeteria plan must be sufficient to provide benefits to qualified employees of at least either:
A uniform percentage of at least 2 percent of compensation (defined as it is under Code Section 414(s) for retirement plan purposes, whether or not the employee makes salary reduction contributions to the plan);or
The lesser of a 200 percent matching contribution (or more, if specified by the plan) or 6 percent of the employee’s compensation.
Additional contributions can be made, but the rate of any matching contribution for HCEs or key employees cannot be greater than the rate of the match for the qualified employees (the participating employees other than key and highly compensated employees).
The minimum contribution must be available for application toward the cost of any qualified benefit (any permitted benefit other than a taxable benefit) offered under the plan.
Does the Matching Contribution Method Require a 100% or 200% Employer Match?
The 200 percent matching requirement may be only a 100 percent requirement. An argument may be made for counting an employee’s salary reduction contributions when determining whether an employer has contributed “twice the amount of the [employee’s] salary reduction contributions.” Arguably, the law calls for the employer to contribute the employee’s salary reductions (which are employer contributions for tax purposes) plus a 100 percent match, for a total contribution equal to twice the employee’s salary reductions. Another reading is that the employer must contribute twice the amount of the employee’s salary reductions as matching contributions. The 6 percent of compensation limit applies under either interpretation. The report on health reform by the Joint Committee on Taxation supports the 100 percent view and states that the minimum matching contribution is the lesser of 100 percent of the employee’s salary reduction contribution, or 6 percent of the employee’s compensation for the plan year.
Compensation for purposes of the minimum contribution requirement is compensation within the meaning of Code Section 414(s).
What Happens When an Employer has All HCEs, All Key Employees and No Qualified Employees?
An employer whose workforce consists of only one or more HCEs or Key Employees would not have any qualified employees. The Code’s simple cafeteria plan provisions require a contribution for each qualified employee. Thus, if the plan provides for that contribution but there is no qualified employee, it is not clear whether such an employer would be exempt from this requirement (in which case the plan could be funded entirely with salary reductions) or would be disqualified from having a simple cafeteria plan.
Source: Benefits Pro
