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Who's the Employer?

Answers are provided by S. Derrin Watson, JD, APM

PEO Sponsoring a Cafeteria Plan

(Posted January 25, 2000)

Question 43: This question is about PEO's sponsoring a multiple employer Section 125 (cafeteria) plan. The PEO in question has 6 client companies. The PEO has a Section 125 plan. It allows some of the client-employers to opt out of offering those leased employees the flexible spending account options under the Section 125 plan (only offering them the premium-only option). How can they do this, and still satisfy the "availability" requirement of Section 125 (the rule that all benefits must be reasonably available to all of the employees)? Can each co-employer pick and choose things like premium-only option, cap for medical reimbursements under flexible spending accounts, or eligibility?

Answer: As with all PEO issues, the first question is "Who's the Employer?"

If the PEO is not the common-law employer (and case after case has found that the PEO is not), then the plan violates IRC 125(d). That means every participant (not just the group of highly compensated employees) is taxed as though he or she were in constructive receipt of the monies put into the plan, whether or not the moneys are spent on otherwise nontaxable benefits. (This issue is discussed in more detail in Chapter 4 of my book, Who's the Employer?.)

Let's assume the PEO is the true employer. That means it is the common-law employer of each and every person in the plan. The PEO, then, is left administering the plan as though it were the true employer, not as though the client were the true employer with decisions over benefits.

If the PEO is the employer, then all testing for discrimination, reasonable availability, etc., is done at its level, not at the recipient (client) level.

Of course, assuming it could satisfy the discrimination rules, a PEO could set up separate plans for different groups of workers, with different benefits. Again, each such plan would have to satisfy the nondiscrimination rules, but that is certainly an option, just as a large corporation could set up separate plans for the shipping and sales divisions. Doing so does not violate the "reasonably available" rule, because that rule requires FSA benefits to be reasonably available to all participants, not to all employees.

Important notice:

Answers are provided as general guidance on the subjects covered in the question and are not provided as legal advice to the questioner or to readers. Any legal issues should be reviewed by your legal counsel to apply the law to the particular facts of this and similar situations.

The law in this area changes frequently. Answers are believed to be correct as of the posting dates shown. The completeness or accuracy of a particular answer may be affected by changes in the law (statutes, regulations, rulings, court decisions, etc.) that occur after the date on which a particular Q&A is posted.