President Obama signed The Patient Protection and Affordable Care Act (“the Act”) into law on March 23, 2010. Separately, on March 25, 2010, the Senate and House passed the Health Care and Education Reconciliation Act of 2010 (“the Reconciliation Act”) amending many provisions of the Act. The Reconciliation Act was signed into law by President Obama on March 30, 2010. The tax provisions contained in this major health care overhaul are the subject of a series of Insight articles. The focus of this article is on simple cafeteria plans for small employers.
Under the new healthcare reform package, and effective for taxable years beginning after December 31, 2010, small employers will be allowed to adopt new “SIMPLE cafeteria plans.” Under the new law, SIMPLE cafeteria plans will be treated as meeting nondiscrimination requirements as long as certain eligibility, participation and minimum contribution requirements are met by the plans. The safe harbor would also cover the non-discrimination requirements applicable to certain benefits offered under a cafeteria plan including group term life insurance, coverage under a self insured group health plan and benefits under a dependent care assistance program.
A cafeteria plan (as provided for under Internal Revenue Code Section 125) is an employer sponsored plan under which employees have the option of selecting benefits or cash. Employees can choose which tax free benefits fit their needs or elect to receive taxable cash payments in lieu of unselected benefits. For example, under a cafeteria plan, employees are able to pay their share of premiums for employer provided health insurance on a pre-tax basis through salary reductions. Thus, a cafeteria plan provides tax savings to both employee and employer by reducing premiums from gross salary prior to calculation of federal income and Social Security taxes.
A cafeteria plan must be a written plan and may not discriminate in favor of highly compensated participants or favor key employees. In the past, these non-discrimination rules have discouraged the use of cafeteria plans by small businesses. A violation of the non-discrimination rules results in the taxation of benefits provided by the plan to highly compensated or key employees. Because of the potential taxation of benefits provided by the plan, small employers, who may have a higher percentage of highly compensated or key employees as compared to larger employers, have tended not to provide cafeteria plans to their employees.
The healthcare reform package eases the administrative burden to small businesses of sponsoring a cafeteria plan and provides a safe harbor to the discrimination requirements applicable to highly compensated and key employees.
Employer Contribution Requirement
In order to satisfy the requirements of the new law, an eligible employer must be required to contribute an amount sufficient to provide qualified benefits under the plan on behalf of each qualified employee.
The employer contribution must be equal to either; a uniform percentage (not less than 2 percent) of the employee’s compensation for the plan year, or a 200% match of employee contributions up to 6% of the employee’s compensation for the plan year. The rate of match for highly compensated employees cannot be greater than the rate of match for non-highly compensated employees.
Who Qualifies as a “Small Employer”?
A small employer is defined as having an average of 100 or fewer employees on business days during either of the two preceding years. If the employer was not in existence during the prior year, the determination is made based on the average number of employees that are reasonably expected to be employed on business days during the current year.
Additionally, under a growing business provision, if a business maintaining a SIMPLE cafeteria plan employs more than 100 employees in subsequent year, the SIMPLE arrangement may remain in place until the employer has exceeded an average of 200 or more employees during a preceding year.
Who is an Eligible Employee?
In order to meet nondiscrimination requirements, all non-excludable employees who had at least 1,000 hours of service during the preceding plan year must be eligible to participate in a SIMPLE cafeteria plan.
Excludable employees are those who:
- have not attained age 21 before the end of the plan year;
- have less than one year of service as of any day during the plan year;
- are covered under a collective bargaining agreement; or
- are nonresident aliens.
A plan may provide for a shorter period of service or younger age, if desired. Each eligible employee must be able to elect any benefit available under the plan under the same terms and conditions as all other participants.
The safe harbor SIMPLE cafeteria plan may help more C corporations provide tax free benefits to their employees beginning in 2011. However, the new health care reform legislation did not change current law that precludes sole proprietors, members of limited liability companies and partners in a partnership, and more than two percent shareholders of S corporations from participating in a cafeteria plan. These restrictions will continue to be a major impediment to the use of cafeteria plans by these small businesses.
We encourage you to bookmark our web page dedicated to Health Care Reform for periodic updates.
Schneider Downs provides accounting, tax, wealth management and business advisory services through innovative thought leaders who deliver the expertise to meet the individual needs of each client. Our offices are located in Pittsburgh, PA, and Columbus, OH.
This advice is not intended or written to be used for, and it cannot be used for, the purpose of avoiding any federal tax penalties that may be imposed, or for promoting, marketing or recommending to another person, any tax related matter.