3503 / What are the income tax benefits of a cafeteria plan?

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.²

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.³

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 the annual contribution cap ($3,300 for 2025, $3,200 for 2024, $3,050 for 2023 and $2,850 for 2022, as adjusted annually for inflation) made to the FSA.⁴

Under IRS Notice 2012-40:

(1)     the contribution limit does not apply for plan years that begin before 2013;

(2)     the term “taxable year” in IRC Section 125(i) refers to the plan year of the cafeteria plan, as this is the period for which salary reduction elections are made;

(3)     plans were permitted to adopt the required amendments to reflect the contribution limit at any time through the end of calendar year 2014;

(4)     in the case of a plan providing a grace period (which may be up to two months and 15 days), unused salary reduction contributions to the health FSA for plan years beginning in 2012 or later that are carried over into the grace period for that plan year will not count against the contribution limit for the subsequent plan year; and

(5)     unless a plan’s benefits are under examination by the IRS, relief is provided for certain salary reduction contributions exceeding the contribution limit that are due to a reasonable mistake and not willful neglect, and that are corrected by the employer.

For the income tax effect of a discriminatory plan on highly compensated individuals, see Q 3504.