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[Guest mrilao]

Forgive me if this is too basic, but I am new to all this.

The company I just joined offers employees a choice of taking health insurance (a qualified benefit) or taking 1/2 the amount that the premiums would have cost as taxable compensation.

To me this meets the definition in IRC 125 of a cafeteria plan (a choice between cash and qualified benefits). However, all the sources I read only refer to premium conversion arrangements (salary reduced - which is kind of the case, but there is no salary reduction agreement), health FSAs and full-flex credit plans.

They have no documentation calling this a 125 arrangement (as a PD or in the ee handbook) and it has never filed a Form 5000 (which is not an issue anymore).

What do you think?

[E as in ERISA]

I think that you have a problem.

Your case is most similar to the salary reduction premium conversion type arrangement (under a 125 program there is a choice between cash and a nontaxable benefit -- and the IRS has said that includes choice between salary reduction and a nontaxable benefit).

This was the IRS' text from 1998 that it was using to train payroll examiners to audit 125 plans:

http://www.irs.gov/pub/irs-tege/lesson4.pdf

[Guest mrilao]

Thank you for the link! That is what I thought and now it is time to get all the evidence together and break it to management.

Thanks again!

[Guest Jeff V]

I'm not sure about this, 'cuz I'm new to Sec. 125 administration too, but it doesn't sounds like a 125 plan to me. It sounds to me like the employer is offering the choice between TAXABLE compensation (isn't that what the first message said?) or company paid health benefits. The company paid health benefits are more akin to the company paid portion of premiums most employers offer than the employee premium being converted via before-tax in lieu of cash. Please help me understand what I'm confused about here if I am and you can see.

Thanks.

[papogi]

The employer is offering a choice between taxable compensation and qualified benefits. Assume you have two employees, each making $20K. One employee decides not to take the coverage. I think that what mrilao is saying is that this employee’s $20K taxable compensation will rise by ½ the premium. The other employee decides to take the coverage. His compensation stays at $20K. If my assumption is correct, this would be a 125 plan. Because the employee who decided to take the coverage now has lower taxable income, he essentially purchased the coverage with pre-tax dollars, so 125 has to be involved. Most companies give you nothing, and ask you to reduce income and buy coverage with pre-tax dollars. This employer gives you something, then says if you don’t want it, you’ll get more money. Either way, the participants have lower taxable income, and the non-participants have higher taxable income, so it is 125.

[Guest Jeff V]

Papa, thanks for setting me straight on that point.

How about this for a reason they're not a 125 plan: they don't have a plan document. Since Sec. 125 requires a 125 Plan to be in writing, does this fail to be a 125 plan, and there is constructive receipt?

Thanks again, you are good to read.

[GBurns]

There are many lawyers who take the position that this is a plan set up under Section 106 not 125 and therefore does not need a Plan Document. However, there could be the issue that although the IRC might not require a PD, the DOL usually does although this is debatable.

The rationale behind the section 106 reasoning is the same that was used in a number of cases on this 106 vs 125 issue that the IRS lost even on appeal in at least 3 different circuits. An example is the Express Oil Change case which is one of the few in which the judge refused to the IRS request for an unpublished decision.

If you look at any PLR issued since 1989 with a UIL 106 and which involves a cafeteria plan, you will see that every one makes the statement, in the conclusion, to the effect "Amounts by which an employee elects to reduce his compensation and which amounts are allocable to group health insurance coverage and medical reimbursement coverage are not includable in the gross income of the participant pursuant to section 106 of the Code".

This wording is used in numerous PLRs. There is never wording saying "pursuant to section 125".

This could be because there are no applicable Treasury Regulations for the majority of section 125. And as per the just released Revenue Procedure 2002-3 the IRS is still taking the position that they have been taking offically since 1989 that they will not rule as to whether or not the amount that he employee elects to reduce from his compensation is tax-free or not.

Since Proposed Treasury Regulations are treated by a large number of courts including the US Supreme Court as having "no effect of law", many practitioners will go with what is actual law and that which is supported by a large body of case law namely that section 106 rules.

[papogi]

Gburns has some good points concerning 106. My opinion is that this plan does require a 125 document, however. Since the value of ½ the premium is available as cash or benefits, then all employees are in constructive receipt of that ½ premium without 125. The employee who decides to take the coverage in lieu of the cash is in constructive receipt of ½ the premium, so they need to pay tax on that amount, unless a 125 plan is in place.

[Kirk Maldonado]

I think that you need a cafeteria plan document. The IRS has litigated this issue in court and won.

[GBurns]

Whether a cafeteria plan a 105 or if you deem this as being controlled by 106, it is prudent to have a Plan Document in every case.

Kirk....

As to the IRS litigating and winning, I have to ask .. What was the issue of the litigation ? Was it as to whether or not a plan such as described by mrilao was a cafeteria plan or not or was it to determine if a cafeteria plan does need a PD?

[Guest many?s]

What if the employer charged employees $10 per pay period for the health benefit on an AFTER TAX basis, but gave employees who did not elect the health benefit $30 on an after tax basis?

Would it make a difference if the dollar amount were the same?

Is a Section 125 plan needed in either of these scenarios since the health benefit is being paid for with after-tax dollars (Even though the value of the benefit is greater than $10)

[papogi]

Great question. Assume you have two employees, each making $20K. Under your example, the participants still have $20K taxable (since the premium is taken post-tax). The opt-outs are given additional compensation, and this money is taxable, as in any 125 plan, as well. The bottom line is that participants have lower taxable income than non-participants, so they are effectively trading compensation for qualified benefits. Had they not elected the benefit, they would have greater taxable income.

Purchasing benefits with after-tax dollars does not require a 125 document, and this is not the sticking point in this case. The issue comes up when an employer gives extra compensation to non-participants. If there’s a choice between taxable cash and qualified benefits, then there’s a need for 125. That’s how I read it, anyway.

[Steve72]

Papogi:

What if the election were made a condition of employment? I.e., the election to take additional cash compensation or benefits was a one-time election at date of hire, and was not subject to annual changes.

[GBurns]

Steve72

Whether done as a one time election or not, it could be done as under section 106 as per Express Oil Change and others. However, the risk of IRS contesting it is still great so it makes sense to get rid of the IRS issue and use a section 125 plan.

[Guest Jeff V]

Just when I thought I was following this thread, you guys go on a conceptual journey that makes me realize I'm not speaking your language.:confused: