Employer Premium Payment Outside Cafeteria Plan

Forgive the very basic question, but is it permissible for an employer to pay, on a tax-free basis, all or a portion of one employee's fully insured group health premiums outside of the employer's cafeteria plan? Assume the one person is highly compensated. 

No nondiscrimination rules would be directly applicable because the group health plan is fully insured. Would the cafeteria plan nondiscrimination rules cover this type of payment?

In other words, does the existence of the cafeteria plan (and the other non-HCEs' requirement to pay a larger premium under the cafeteria plan) eliminate the ability for the employer to make tax-free premium payments under section 106?

That's a great question.  It's really not basic--I've debated this one with ERISA attorneys for years. 

I've always taken the position that the uniform election rule in the Section 125 nondiscrimination provisions requires that HCPs pay at least as much as non-HCPs for the same plan options.  In other words, a contribution structure that charges more to certain non-HCPs for the same benefit does not provide a “uniform election with respect to employer contributions.”  So all full-time non-HCP employees eligible for the same plan option as an HCP must be offered at least the same employer contribution amount that is available to the HCPs for that plan.

• More details: https://www.newfront.com/blog/nondiscrimination-rules-for-different-health-plan-contribution-structures-2

Now there are a couple reasonable arguments that if there is no HCP contribution to the plan, the §125 rules do not apply.  One argument is based on the so-called "American Can Plan" approach.  However, the American Can Plan proposition I've always understand as there actually not being a Section 125 cafeteria plan in place.  That's different in my opinion than arguing the non-highs are using the 125 plan but the highs aren't because they're not required to contribute.

Then there's the argument that what happens if you violate the 125 NDT rules with this type of structure.  The rules technically provide that the HCPs would lose the safe harbor from constructive receipt, and thereby be taxed on any pre-tax contribution.  But there are no pre-tax contributions in this situation.  So my argument is essentially that the IRS would try to force them to lose the tax-free premium treatment under §106 as you noted.

In short, I've just always thought it is pretty ridiculous to believe the IRS would be ok with highs paying zero, but not with them paying one cent pre-tax.  But there's no guidance I'm aware of directly on point.

So that's how I advise unless the highs at issue are ineligible for the cafeteria plan, such as more-than-2% S corp owners, K-1 partners, LLC members, etc.  In that case I'm fine taking the position that because they're treated as self-employed and therefore ineligible to participate in the cafeteria plan, the employer is prebaby fine providing a larger employer contribution.

Thanks so much, Brian. Very helpful.

Good Evening,

Simple solution, known by a few, raise the HCP wages by the desired difference between 100% cost of the benefit plan and the normal non-HCP contribution amount.  Then the HCP employee can chose to pay that additional wage as a pre-tax contribution in Section 125 Plan, while the employer continues to make comparabe tax-free contributions for all HCP and Non-HCPs eligible benefits.  Assuming the HCE at issue is not ineligible for the cafeteria plan, such as more-than-2% S corp owners, K-1 partners, LLC members, etc, as Brian has stated.

BRIAN,

Do you agree, as one HCE or multiple HCE paid non-discriminitory amount(s), as HCEs are able to make S125 pre-tax contributions as long as they are not lower than the non-HCPs pre-tax contributions?

Scott, thanks, and I agree that's a simple solution for tax purposes. Sometimes I will have clients push back on that approach as it means they are offering one person (and not others) a higher base salary, which can cause some HR heartburn for various internal business reasons. 

Yeah I agree that's the best workaround, Scott.  Catty, they could structure it as a bonus if that helps.

Brian, that's a great analysis, but I would take the contrary position. Current law (until IRS publishes regs) permits employers to discriminate in favor of HCPs for medical benefits if plan is fully insured. And Sections 105 and 106 tell us that neither highly compensated nor non-highly compensated will have income based on medical plan contributions or benefits. The only thing that 125 does is allow employees to get around constructive receipt if they are given a choice between cash and benefits. If the employer covers all of its HCPs, or a subset chosen by the employer in its sole discretion, mandatorily for insured medical , then constructive receipt is not an issue, and the benefit is provided separately from the cafeteria plan. If the employer only covers some highly compensated and lets  others decline and take more cash, outside the cafeteria plan, then all of the HCEs would potentially be in constructive receipt, even those who took benefits. That's at least the way I've always viewed it.