Cafeteria Plan

A cafeteria plan is a separate written benefit plan maintained by an employer for the benefit of its employees, under which all participants are employees, and each participant is provided with the opportunity to choose among two or more benefits, consisting at least of cash (or a taxable benefit which is treated like cash under the section 125 regulations) and one "qualified benefit." Qualified benefits are excludable from an employee's gross income. Even though section 125 and its regulations are silent, it appears that not all benefits under a cafeteria plan have to be optional as long as there are at least two optional benefits, one taxable and one "qualified."

The vast majority of cafeteria plans are funded by salary reduction arrangements. With respect to these plans, each eligible employee has the option of permitting normal salary reductions and having the amount of the reduction applied toward purchasing one or more qualified benefits. Any salary reduction agreement for nontaxable benefits with a health and welfare benefit is automatically a cafeteria plan, because the employee has a choice between salary and a nontaxable benefit, i.e., the health or other welfare benefit to which the salary reductions are applied. Similarly, if an employer provides a cash payment to employees who opt out of coverage under an employer-sponsored health plan, the arrangement constitutes a cafeteria plan and must be treated as such. Other cafeteria plans provide a supplement to normal salary. In those plans the employer makes contributions available which participants may elect to receive in the form of cash or to apply toward the purchase of one or more qualified benefits. A combination of these two approaches may also be made available.

Taking a more formal look at the available cafeteria plans, there are four principal forms that a cafeteria plan may take. The first is a basic premium conversion plan. This is the simplest form of cafeteria plan, enabling participants who are covered by a contributory medical plan to have their mandatory contributions changed from after-tax to pre-tax dollars by satisfying the requirements of section 125. The second form of cafeteria plan is a complex premium conversion plan. This plan is like the first form, except that the participants are given a choice of various medical plans, each of which may have a different level of mandatory employee contribution. Whichever medical plan is selected, the participant is allowed to make the mandatory contributions on a pre-tax basis by employing section 125.

The third form of cafeteria plan is a conversion plan with one or more flexible spending accounts. Under this arrangement, the participants are allowed to participate in one or more flexible spending accounts as a supplement to their medical plan coverage. The final form is an employer credit plan. Under this form of cafeteria plan, the employer provides each participant with a specified number of credits that are usually sufficient to enable the participant to "purchase" a minimum level of benefits without any out-of-pocket cost to the participant. The participant may elect to "spend" the credits on more expensive benefit plans and to contribute them to one or more flexible spending accounts. If the cost of the benefits elected by a participant exceeds the value of the employer-provided credits, the participant makes up the difference, using the section 125 pre-tax conversion feature. Furthermore, in each form of cafeteria plan, a medical plan may be replaced or supplemented by any other plan that provides another type of qualified benefit.

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