The new health reform law adds a new provision of particular interest to small employers: "simple" cafeteria plans.
"Simple" cafeteria plans are not subject to the nondiscrimination requirements applicable to regular cafeteria plans. This includes the "25% limit" of IRC Sec. 125(b), which limits business owners and their family members to no more than 25% of the total benefits flowing through a regular cafeteria plan in any year. Again, this limit does not apply to simple cafeteria plans.
For example, assume a company with two owners and five employees. And assume that the five employees together defer $3,000 of their wages to company’s cafeteria plan to pay for their medical and childcare costs on a pre-tax basis. And assume that together the two owners have a total of $6,000 of medical and childcare expenses which they pay personally, after-tax. In a regular cafeteria plan, the owners would be limited to $1,000 in pre-tax benefits without violating the 25% rule [$1,000 ÷ ($1,000 + $3,000) = 25%]. But in a simple cafeteria plan, the owners could pay all $6,000 of their medical and childcare expenses on a pre-tax basis.
There are three requirements to qualifying a cafeteria plan as a "simple" cafeteria plan:
Simple cafeteria plans are limited to employers with no more than 100 employees. The simple cafeteria plan works best for owners of "C" corporations. Owners of "S" corporations, LLCs or sole proprietorships cannot participate in a cafeteria plan, including a simple cafeteria plan. However, employed spouses of owners in an LLC or a sole proprietorship can be covered in a simple cafeteria plan as employees in their own right, and they can elect pre-tax benefits for their families including the owner-spouse. This provision can work well in a small family business where both spouses are involved.
The sponsor of a simple cafeteria plan must make an employer contribution to the plan to provide medical or childcare benefits in an amount equal to at least 2% of each eligible employee’s compensation for the year. This is the "cost" of a simple cafeteria plan over a regular cafeteria plan. However, in many small businesses this "cost" is worth the benefit of enabling owners to convert their own medical and childcare costs into pre-tax expenses.
A simple cafeteria plan must cover all employees who had at least 1,000 hours of service for the preceding plan year. An employer may exclude employees who have not attained the age of 21 or who are covered under a collective bargaining agreement. All eligible employees must have the same election rights under the plan.
We have implemented a simple cafeteria plan for our own law firm, for the reasons stated above. If you are interested in exploring this opportunity for your company, whether to establish a new simple cafeteria plan or to amend your existing cafeteria plan into a simple cafeteria plan, please contact us.