Cafeteria Plans for Small Employers?

[Guest RW]

Any guidance, references on whether cafeteria plans are suitable for very small employers? The only real benefit would be a scaled down health plan.

[GBurns]

Cafeteria plans can be used by any size employer. The purpose usually is to reduce the cost, to the employee,for participating (cost sharing). In some cases the money saved by the employee will allow them to purchase other benefits. The employer can also use it as a cost reduction technique.

What do you mean by "scaled down health plan"??

[Guest RW]

"Scaled down" means very basic coverage with very affordable rates.

[Guest nherkowitz]

Cafeteria Plans can be very useful for a small business, but you need to plan carefully. Most cafeteria consulting & marketing firms don't see much money for small plans, so it is generally underutilized in a small plan.

You need to watch out for the 25% aggregate benefits test. This test does not allow benefits for key employees (generally owners & family) to exceed 25% of the total benefits under the cafeteria plan. There is a similar test in a dependent care plan under section 129

There is a similar test in section 129 which would apply if you have dependent day care expenses in your cafeteria plan. This test states that the average benefit for non-highly compensated employees cannot be lower than 55% of the average benefit for highly compensated employees.

These discrimination rules are a major planning factors under small cafeteria plans.

[Guest wnicholas]

Cafeteria Plans for small employers require caution. First, the discrimination rules can turn sour quickly for a small plan and secondly you have to identify the organizations tax form. For example, 2% shareholders in an SCorp, Partners, in a Partnership, and LLC's filing as a partnership can not use a Section 125 plan's advantages.

[Guest Joe Vasko]

While these types of entities prohibit participation by the shareholders/owners, they may still sponsor a Cafeteria Plan for the other employees. A POP may be useful for handling pre-tax insurance premiums. Easy to set-up and administer.

[Guest Matt Tuttle]

You may want to look at a Voluntary Employee Medical Account (VEMA) plan instead. It has many of the same aspects as the cafateria plan but it is not a use it or lose it and it doesn't have the discrmination or top heavy problems. The only problem is the set up fee is around $5,000 so if the employer is really small it may not work.

Matt Tuttle

[Guest Cynthia g]

OK Uncle... I have searched the Code and 125 regs for "proof" tht partners and Sub S shareholders cannot participate in a cafeteria plan. I know it to be true. Where is the documentation?

[KJohnson]

This is from the old 125 Plan Q&A column

Question 6: When can a company owner (whose spouse is also an employee) make use of pre-tax dollars in a Section 125 Plan? The owner holds 100% of the company ownership. Assume that discrimination is not an issue.

Answer: Code §125(d)(1)(a) states that all participants in a cafeteria plan must be employees. The proposed regulations at §1.125-1 Q&A-4 define what is meant by "employee."

The term "employees" includes present and former employees of the employer. All employees who are treated as employed by a single employer under subsections (B), ©, or (m) of section 414 are treated as employed by a single employer for purposes of section 125. The term "employees" does not, however, include self-employed individuals described in section 401© of the Code.

Further, it appears that persons who own more than 2 percent of the shares of an S corporation are not considered "employees." (An S corporation is a corporation that has elected to be treated as an "S" corporation for income tax purposes, pursuant to subchapter S of the normal income tax provisions in the Code.) See Code section 1372, which states that for purposes of the "fringe benefits" portions of the Code an S corporation is treated as a partnership and a more than 2 percent shareholder of the S corporaiton is treated as a partner of such partnership.

Remember to apply the "attribution" rules of Code section 318. The spouse of a 100% owner of an S corporation, LLC (Limited Liability Corp.) or a sole proprietorship would be considered to be the 100% owner as well. In this question, therefore, neither the company owner nor the owner's spouse could participate in the cafeteria plan.

If the corporation is a C corporation for federal income tax purposes, nothing prevents the 100% owner of the corporation's shares from participating. He or she could be an employee and therefore eligible for participation. The spouse of the 100% owner also would be eligible for participation even though attribution would apply to a C corporation owner's spouse.

Here's the interesting tidbit. A sole proprietor who employs his or her spouse (as a bona fide employee!) may not participate in a Section 125 plan, but the spouse may participate! This is because there are no shares to attribute in a sole proprietorship.

Incidentally, this method also applies to family health insurance coverage. The non-owning spouse could elect family coverage (covering, as a dependent, the spouse with 100% ownership of the company.) The health insurance premium would be completely deductible