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Cafeteria Plans, § 125

29 July, 2015 - 16:31

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?