Normally, a taxpayer may not avoid realizing gross income by turning his/her back on cash. Hence, if an employer were to give all employees a choice between, say, $5000 cash or $5000 of dependent care assistance, taxpayer would have to realize gross income no matter which choice s/he made. Either the employee accepted the cash (taxable) or could have accepted the cash (also taxable).
Some of an employer’s workforce might be parents whose children are in need of, say, after-school care. In order to avoid application of this “constructive receipt”
doctrine, the employer would have to offer a dependent care assistance program to all employees.
- The non-parents would give up wages for this benefit, even though they derive no value from it.
- If the employer did not offer such a program, the parents could not avail themselves of the § 129 exclusion.
Section 125 mitigates these effects substantially, and gives employers and employees the power to customize a benefits package to a point – or to accept cash. A participant in a “cafeteria plan” does not realize gross income simply because s/he may choose to receive cash or among qualified benefits of the plan that the employer offers.
- Section 125(f) defines a “qualified benefit” to be any benefit which is not includible in the gross income of an employee except for § 106(b) (Archer MSAs),
§ 117 (scholarships, qualified tuition reduction), § 127 (employer educational assistance programs), and § 132 (fringe benefits).
- However, qualified transportation fringes are treated in the same manner as other qualified benefits of a cafeteria plan, § 132(f)(4).
- Moreover, group-term life insurance (see ¶ 79) in excess of $50,000 is a qualified benefit.
- Reg. § 1.125-1(a)(3) lists qualified benefits that an employer may offer in a cafeteria plan.
Section 125(j) establishes “simple cafeteria plans for small businesses.”
Proposed Reg. § 1.125-5(a)(1) authorizes flexible spending arrangements whereby employees agree to a reduction in their salary to be spent on a use-it-or-lose it basis on qualified benefits.
Why should an employer offer a cafeteria plan?