Cafeteria Plan

James Parker
May 22, 2022

What Is a Cafeteria Plan?

A cafeteria plan actually has nothing to do with food offered by an employer. Instead, it refers to a series of benefits that employees can choose, similar to choosing meal options in a cafeteria. These benefits are special because they are deducted from the employee’s pay before payroll taxes are calculated.

By deducting the benefits before taxes, the employee’s gross taxable income is reduced, making the benefits tax-free as well as decreasing the amount of payroll taxes that the employee owes. According to the Internal Revenue Code (IRC) section 125, cafeteria plans are exempt from federal income tax calculations meaning that in addition to reducing payroll taxes, cafeteria plans reduce income and social security withholding as well. The only exception is with certain benefits, like group life insurance plans that exceed $50,000, which require social security and medicare withholding for those specific benefits. 

Some other examples of benefits that may be offered under a cafeteria plan include:

  • Adoption assistance plans
  • Cash benefits
  • Dental insurance
  • Disability insurance
  • Flexible spending accounts
  • Health insurance
  • Health savings accounts
  • Vision insurance

All of these benefits are provided at the employer’s discretion but can serve as an invaluable method for allowing employees to customize their insurance options and care.

Key Takeaways

  • A cafeteria plan is a bevy of options offered by an employer for a variety of benefits that can be purchased with pre-tax income.
  • Cafeteria plans are advantageous for employees because they allow the employee to use pre-taxed income to purchase benefits which reduces the tax burden on the employee and allows the benefits to also be untaxed.
  • Cafeteria plans can include health insurance, dental, vision, life insurance, and a variety of other plans, some of which may be taxable at a later date.
  • If you have experienced discrimination when filing for your employer’s cafeteria plan, or you have been using a plan that turned out to be out of compliance, an experienced Employment Law attorney may be able to improve the outcome of your case by utilizing experience and expert knowledge to get you the compensation that you deserve.

Cafeteria Plans, and Employment Law

Cafeteria plans are regulated by section 125 of the U.S. Code. Not all employers are compliant with section 125 since the payroll service companies do not always monitor for section 125 compliance. This can result in a company that is out of compliance being audited with disastrous results for the unwitting employees.

A company that is found to be out of compliance with section 125 will require taxes to be paid on all of the benefits that were purchased under the cafeteria plan, sometimes as a single lump sum. This can devastate the finances of employees who did not know that the benefits were not being offered in compliance with section 125. 

Section 125 also has a nondiscrimination clause. Unlike most protected classes, however, section 125 protects lower-income employees by not allowing employers to offer cafeteria plans to only highly compensated or key employees. 

Section 125 defines a highly compensated employee as any employee, spouse, or dependent of an employee, who is:

  • An officer of the company
  • A 5% shareholder in the company
  • An employee with annual compensation that exceeds a set amount listed in section 125
  • An employee whose salary is in the top 20% of all employees where the employer opted into certain conditions.

Section 125 describes key employees as any employees, spouses, or dependents of employees, who are:

  • An officer of the company with annual compensation above the limit set by the section 125 regulations
  • A 1% owner  of the company with compensation of $150,000 or more
  • A 5% owner, regardless of their compensation amount

Section 125 also includes a test regarding eligibility, contributions, and individual and total benefits to determine whether a company is being discriminatory with their cafeteria plan. If an employer is subject to the section 125 test and is found to offer a cafeteria plan that is discriminatory, all of the discriminatory benefits lose their tax-exempt status and are included in the gross income of the highly compensated or key participants who received them.

Bottom Line

If you have been sold a cafeteria plan that was out of compliance, or you have been excluded from a cafeteria plan for discriminatory reasons, you may be able to seek compensation and benefits from your employer. In order to accomplish this, you will need an Employment Law attorney.

An experienced Employment Law attorney can help you achieve the best possible outcome for your case by leveraging their expertise in cafeteria plan law, using practiced trial tactics, and drawing from a pool of expert witnesses to advocate on your behalf.

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