can a 125 plan include a SUB option?

[Guest jls42]

Is it possible for a cafeteria plan to give employees the option of making pretax contributions to a SUB fund whereby the employer will not have to pay FICA/FUTA taxes and the employee does not have to use after-tax dollars?

[jmor99]

It depends on what you mean by a "sub" fund. Do you mean such as an HSA? The answer would be yes.

Does the sub fund provide for deferred compensation? The answer would be "no" unless you're talking about a 401-k or "certain plans maintained by educational institutions" having to do with post-retirement group life ins.

[Lori Friedman]

It depends on what you mean by a "sub" fund.

A "SUB fund" is a trust -- tax-exempt within the meaning of I.R.C. Sec. 501©(17) -- that funds a supplemental unemployment benefit plan. Usually, the trusts are employer-financed (no employee contributions). Benefit payments aren't unemployment compensation; they're wages, subject to withholding and payroll taxes.

jls42, it sounds as if you're describing a private (nonunion) trust with voluntary employee contributions. I can't find any specific guidance about a relationship between Sec. 501©(17) and Sec. 125, but I'll try to answer your question from some available information.

1. When an employee contributes to a SUB plan, he has basis in his contributions. In other words, the contributions are made with after-tax dollars. If he eventually receives any benefits from the trust, his payments are taxable only if the amounts received exceed his total contributions. The employee effectively recovers his own contributions first. [Reg. Sec. 1.501©(17)-3(a)(1); Rev. Rul. 57-383]

2. An employee can't receive any deduction for SUB plan contributions [Rev. Rul. 57-383; Rev. Rul 67-38].

3. There are "laundry lists" of benefits that qualify for Sec. 125 inclusion and benefits that are specifically forbidden. SUB contributions don't appear on either list.

Given what we do know, I would take the position that SUB contributions can't be elected pre-tax through a cafeteria arrangement.

I'll be interested in reading other people's thoughts and comments. But, the information's difficult to find. Sec. 501©(17) trusts are fairly uncommon, and a lawyer or accountant can spend an entire career specializing in tax-exempt organizations yet never encounter one.