Employers that provide health and other welfare plan benefits on a pre-tax basis through a cafeteria plan must have a written document describing the rules relating to the pre-tax arrangement. As a condition of receiving favorable tax treatment, the IRS requires each cafeteria plan under section 125 of the Code to be properly documented.
A cafeteria plan is a separate written plan maintained by an employer for employees that meets the specific requirements Code section 125. It provides participants an opportunity to receive benefits on a pretax basis. Participants in a cafeteria plan must be permitted to choose among at least one taxable benefit (such as cash) and one qualified benefit (such as medical coverage). Health FSAs are a benefit that must be evidenced in a written cafeteria plan document.
If a plan is not in writing or does not operate according to its written document, the plan could lose its tax-favored status resulting in tax liability for both the employer and its employees.
Proper documentation will describe which benefits are eligible to be paid with pre-tax dollars, along with eligibility requirements and periods of coverage. Restrictions on changes in pre-tax contributions will be identified. So-called "life events" must be spelled out with the parameters for enrollment and mid-year election changes. Funding must be described, along with an explanation of employer and employee contribution procedures. Any flexible spending account arrangements should also be described.
Implementing a written cafeteria plan is a step that should be taken toward compliance with IRS rules.
