August 24, 2007

IRS issues proposed regulations on cafeteria plans, clarifies previous guidance

IRS issues proposed regulations on cafeteria plans, clarifies previous guidance
On August 6, the Internal Revenue Service (IRS) issued new proposed regulations regarding cafeteria plans. Under Section 125 of the tax code, cafeteria plans (sometimes called Section 125 plans) allow employees to withhold a portion of their pre-tax salary to cover certain medical or child-care expenses.

Until now, cafeteria plans have been regulated by a scattered set of prior proposed regulations, IRS rulings and temporary guidance. The new proposed rules aim to consolidate this previous guidance and clarify cafeteria plan features and requirements. While cafeteria plan rules will generally remain unchanged under the new regulations, there are some new requirements to be aware of, and employers should closely examine their plans and determine whether they should be changed.

In particular, employers should note the following highlights:

• Under the new proposed regulations, cafeteria plans are the sole means by which employers can allow employees to elect between taxable compensation and nontaxable benefits. Employers should check their plans to make sure they fit the cafeteria plan definitions and requirements set forth in the proposed regulations.
• The new proposed regulations clarify that cafeteria plans must be in writing and must be operated under the written plan terms. The written plan must specifically define the plan year and describe all benefits, maximum contribution amounts, eligibility rules, how to make elections and how employer contributions may be made under the plan.
• The new proposed regulations permit a cafeteria plan, except FSAs, to pay for or reimburse COBRA premiums and accident and health insurance premiums.
• Employers that provide FSAs must comply with the uniform coverage rule and the use-it-or-lose rule and include these provisions in the written cafeteria plan.
• The new rules provide guidance and definitions for determining if a cafeteria plan is in compliance with nondiscrimination rules.

The IRS has proposed that these rules go into effect January 1, 2009, but employers may choose to rely on the rules immediately.

View the new proposed regulations.