A cafeteria plan allows employees to choose between receiving cash or
taxable benefits instead of certain qualified benefits that could be excluded from
Taxability of Qualified Benefits
If an employee chooses a qualified benefit, the fact that cash or a taxable
benefit could have been chosen does not make the qualified benefit taxable.
Therefore, qualified benefits provided under a cafeteria plan can be tax-free.
Cash payments or unqualified benefits would be taxable.
What Can Be Included
Cafeteria plans do not normally include any deferred payment benefit plans,
although they can include a qualified 401(k) plan. Other qualified benefits
that could be included in cafeteria plans are accident and health benefits (but
not medical savings accounts or long-term care assistance), adoption
assistance, dependent care assistance, and group-term life insurance coverage.
What Cannot Be Included
A cafeteria plan cannot include Archer medical savings accounts, athletic
facilities, de minimus benefits, educational assistance, employee
discounts, lodging on business premises, meals, moving expense reimbursements,
no-additional-cost services, transportation (commuting) benefits, tuition
reduction, working condition benefits, or scholarships or fellowships. These
benefits are treated separately.
Plans that Favor Highly Compensated Employees
If a cafeteria plan favors highly-compensated employees, in terms of
eligibility to participate, and the contributions and benefits provided, the
beneficiaries’ compensation will include the value of the taxable benefits they
could have selected. Highly compensated employees, for this purpose, include
officers and shareholders who own more than 5% of the employer’s stock,
employees who are highly compensated based on the facts and circumstances, and
the spouses and dependents of any of these employees.
Plans that Favor Key Employees
As in the case of highly-compensated employees, if a plan favors key
employees, they are taxed on the value of taxable benefits they could have
selected. A plan is considered to favor key employees if more than 25% of the
total nontaxable benefits go to key employees. Key employees include officers
who receive annual pay over a certain amount, employees who own at least 5% of
the business, and employees who own at least 1% of the business and receive
annual pay over a certain amount. The amounts may change year by year, and are
published by the Internal Revenue Service.