Employee Benefits and Taxes: Cafeteria Plans

As part of AdvisorOne’s Special Report, 20 Days of Tax Planning Advice for 2013, throughout the month of March, we are partnering with our Summit Business Media sister service, Tax Facts Online, to take a deeper dive into certain tax planning issues in a convenient Q&A format. In this sixth article, we look at income taxes and cafeteria plans.

Q. What are the income tax benefits of a cafeteria plan?

As a general rule, a participant in a cafeteria plan is not treated as being in constructive receipt of taxable income solely because he has the opportunity—before a cash benefit becomes available—to elect among cash and “qualified” benefits (generally, nontaxable benefits).

In order to avoid taxation, a participant must elect the qualified benefits before the cash benefit becomes currently available. That is, the election must be made before the specified period for which the benefit will be provided begins—generally, the plan year.

A cafeteria plan may, but is not required to, provide default elections for one or more qualified benefits for new employees or for current employees who fail to timely elect between permitted taxable and qualified benefits.

Note that a benefit provided under a cafeteria plan through employer contributions to a health flexible spending arrangement (FSA) is not treated as a qualified benefit unless the plan provides that an employee may not elect for any taxable year to have salary reduction contributions in excess of $2,500 made to the FSA. Under IRS Notice 2012-40:

(1) the $2,500 limit does not apply for plan years that begin before 2013;