Section 125 / Cafeteria Plans:

These frequently asked questions and answers are provided for general information only and should not be cited as any type of legal authority. They are designed to provide the user with information required to respond to general inquiries. Due to the uniqueness and complexities of Federal tax law, it is imperative to ensure a full understanding of the specific question presented, and to perform the requisite research to ensure a correct response is provided.
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1. Is there a filing requirement for a town that maintains a cafeteria plan?
2. A town has a cafeteria plan (section 125 plan), which offers dependent care assistance. The benefits received by an employee exceed ,000. How is this benefit reported on Form W-2?
3. What remuneration under a cafeteria plan is not subject to FICA, FUTA, Medicare tax or income tax withholding?
4. How does a cafeteria plan work?
5. A town has a cafeteria plan which offers health care benefits to domestic partners. Does a domestic partner and his or her child qualify to be covered under the health plan?
6. What if the employer does not have a section 125 plan, but offers health insurance coverage to a domestic partner and his or her child? Is this a taxable fringe benefit to the employee?
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Is there a filing requirement for a town that maintains a cafeteria plan?
Generally, no. If you only have a cafeteria plan, you are not required to file Form 5500 or Schedule F. However, if you have a welfare benefit plan, you may be required under Department of Labor regulations to file a return for that plan. Please see the Form 5500 Instructions or contact the U.S. Department of Labor for more information. Assistance is also available from our Customer Account Services office.
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A town has a cafeteria plan (section 125 plan), which offers dependent care assistance. The benefits received by an employee exceed ,000. How is this benefit reported on Form W-2?
An employee can generally exclude from gross income up to ,000 of benefits received under a dependent care assistance program each year. The limit is reduced to ,500 for married employees filing separate returns. The exclusion cannot be more than the earned income of either the employee or the employee’s spouse. The total dependent care benefits the employer paid to the employee or incurred on the employee’s behalf (including amounts from a section 125 plan) should be reported in Box 10 of Form W-2. Any amount over ,000 should be included in Boxes 1, 3, and 5, as “wages,” “social security wages” and “Medicare wages.” See Publication 535 and Publication 15-A for additional information.

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What remuneration under a cafeteria plan is not subject to FICA, FUTA, Medicare tax or income tax withholding?
Generally, qualified benefits under a cafeteria plan are not subject to FICA, FUTA, Medicare tax, or income tax withholding. However, group-term life insurance that exceeds ,000 of coverage is subject to social security and Medicare taxes, but not FUTA tax or income tax withholding, even when provided as a qualified benefit in a cafeteria plan. Adoption assistance benefits provided in a cafeteria plan are subject to social security, Medicare, and FUTA taxes, but not income tax withholding. If an employee elects to receive cash instead of any qualified benefit, it is treated as wages subject to all employment taxes. For more information, see Publication 535, Chapter 5 or Publication 15-A .

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How does a cafeteria plan work?
Code section 125 makes it possible for employers to offer their employees a choice between cash salary and a variety of nontaxable benefits (qualified benefits).

A qualified benefit is a benefit that does not defer compensation and is excludable from an employee’s gross income under a specific provision of the Code, without being subject to the principles of constructive receipt. Qualified benefits include health care, vision and dental care, group-term life insurance, disability, adoption assistance and certain other benefits. See Sections 125(a), 125(f), 79, 105, 106, 129 and 137 of the Code.

Employers may also offer flexible spending accounts to employees under a cafeteria plan that provides coverage under which specified, incurred expenses may be reimbursed. These include health flexible spending accounts for expenses not reimbursed under any other health plan and dependent care assistance programs.

Employer contributions to the cafeteria plan are usually made pursuant to salary reduction agreements between the employer and the employee in which the employee agrees to contribute a portion of his or her salary on a pre-tax basis to pay for the qualified benefits. Salary reduction contributions are not actually or constructively received by the participant. Therefore, those contributions are not considered wages for federal income tax purposes. In addition, those sums generally are not subject to FICA and FUTA. See Sections 3121(a)(5)(G) and 3306(b)(5)(G) of the Code.

The above discussion provides only the most basic rules governing a cafeteria plan. For a complete understanding of the rules, see the proposed and final regulations under Code section 125.

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A town has a cafeteria plan which offers health care benefits to domestic partners. Does a domestic partner and his or her child qualify to be covered under the health plan?
Cafeteria plans can offer health insurance to employees, their spouses and their dependents. The domestic partner and dependents in this case may not be participants in a cafeteria plan because they are not employees, but the plan may provide benefits to them. For example, a domestic partner may not be given the opportunity to select or purchase benefits offered by the plan, but the domestic partner may benefit from the employee’s selection of family medical insurance coverage or of coverage under a dependent care assistance program.

If the domestic partner and his or her child do not qualify as the employee’s dependents, those individuals may receive coverage under the cafeteria plan on a taxable basis. This means that the fair market value of the coverage for the domestic partner and his or her child must be included in the employee’s wages for purposes of income tax withholding, FICA and FUTA taxes.

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What if the employer does not have a section 125 plan, but offers health insurance coverage to a domestic partner and his or her child? Is this a taxable fringe benefit to the employee?
Employer-provided coverage under an accident or health plan for individuals other than the employee, the employee’s spouse or dependents is included in the employee’s gross income (section 106) The term “dependent” is defined in section 152(a) of the Code. A domestic partner would not qualify unless the dependency tests are met.

Outline as provided by the Internal Revenue Service