Module 6 Section 125 and 126 plans (Issues) Flashcards
Section 125 Cafeteria Plans
Terms:
Define Constructive Receipt
- Compensation/benefits taxable when individual has right to receive — For tax purposes, an individual is in constructive receipt of compensation (and benefits)
at the point that they have a nonforfeitable right to it, regardless of whether the individual has taken possession. The position of the IRS is that once the individual can take possession, taxes are owed on the value. - Section 125 provides an exemption from the doctrine of constructive receipt in that participants may choose not to receive taxable cash, and instead receive nontaxable benefits. The same choice (cash or nontaxable benefits) made in the absence of a Section 125 plan could render the benefits taxable under constructive receipt.
Section 125 Cafeteria Plans
Terms:
Define Payroll Deduction
Before tax or after tax deduction from salary
Section 125 Cafeteria Plans
Terms:
Define Salary Reduction
Method by which pretax dollars are used to
pay for certain nontaxable benefits. IRS allows pretax dollars to be used to pay for certain nontaxable benefits.
Section 125 Cafeteria Plans
Terms:
Define Both
Key Employee
Highly Compensated Individual
■ Key employee — For purposes of Section 125, a key employee is defined as meeting one of the following:
* An officer earning more than the annually indexed maximum compensation per year, adjusted for inflation in $5,000 increments
OR
An owner of 5% of the company
OR
An officer earning more than $150,000 per year who is also an owner of at least 1% of the company
■ Highly compensated individual (HCI) — For purposes of Section 125, a highly compensated individual is defined as
someone who is:
* Officer — an officer in the organization
* Owns more than 5% of shares — a shareholder owning more than 5% of all shares
* Based on facts/circumstances — someone who is highly compensated as determined by all of the facts and circumstances,
OR
– Spouse or dependent of the above. Please note that you do not have to be an employee covered under the benefit program as a spouse/dependent of an officer.
Define Section 125 Cafeteria Plans
The term cafeteria plan refers to a plan under which all participants are employees and the participants may choose among qualified benefits or cash. Cafeteria plans permit employers to make benefits choices available to employees as an alternative
to cash without subjecting them to automatic taxation of cash or currently taxable benefits. A Section 125 plan must offer participants the choice between cash and one or more employer provided benefits.
Under Section 125 Cafeteria Plans what benefits are permissible?
what Health Benefits
What Welfare Benefits
What Retirement Benefits
What can not be included?
Health benefits including medical, HSAs, dental, vision, hearing, prescription drugs and reimbursement accounts
* Welfare benefits including disability benefits, accidental death and dismemberment, dependent care and group term life insurance
* Retirement benefits — 401(k) plans
* Exclusions — The following benefits cannot be part of a cafeteria plan: long-term care, dependent group life, group universal life, fringe benefits, defined benefit pension plan, group legal services and tuition
reimbursement.
What are common Section 125 Cafeteria plan types that began in 1978?
Premium conversion (premium only) — Plans that allow employees to contribute on a pretax basis to any eligible employer-sponsored health or welfare plan
– Employees do not pay federal income tax, Social Security tax (FICA), and state income tax (most states) on premiums
– Employer savings on matching Social Security
Flexible Spending Account (FSA) — Under IRC Section 125, employees can set aside money on a pretax basis to pay for eligible unreimbursed medical and dependent care
expenses. Accounts are subject to annual maximums and forfeiture rules.
– Amounts set aside in employee accounts are free from federal income taxes and typically from Social Security (FICA), state and local taxes.
– Employers generally do not pay FICA on amounts set aside in employee accounts for employees earning less than the Social Security wage base.
– Under the Affordable Care Act, health FSA contributions are limited to $2,500 per year, indexed annually.
– Employers are permitted to allow employees enrolled in a medical FSA to roll over up to $500 to the following plan year. However, an employer cannot allow both the rollover and the grace period provision.
Health Savings Account (HSA) — Under IRC Section 125, employees can set aside money on a pretax basis to pay for
eligible unreimbursed health care expenses. Accounts are subject to annual maximums and are indexed annually for employee and family coverage.
– Must be enrolled in a HDHP to contribute
– Money cannot be lost once in the account, total balance rolls over from year to year
– Employers can provide a match to the employee’s contribution
What are the Key Provisions of 125 Plans?
■ Written plan document required
■ Participants must be employees
■ Eligible benefits or cash — Participants may elect between eligible benefits and cash without constructive receipt.
■ Nondiscrimination tests
What are the 3 nondiscrimination tests associated with 125 Plans?
Eligibility Test
Concentration Test
Benefits test
Regarding section 125 plans how are tax on contributions and benefits administered?
Contributions and benefits are generally taxed based on the election made.
* HCIs and key employees must include in gross income the maximum taxable benefits that could have been elected under the plan.
In a section 125 cafeteria plan when are benefits elections required?
Elections are required prior to beginning of plan year, except for a change in status. For tax purposes, elections must be made by the end of the plan year to coincide with
year-end tax filings.
Under a Flexible Spending account how is the plan structured and which party assumes the insurance risk?
Flexible spending accounts are structured so that employer assumes “insurance risk”
resulting from claims incurred prior to date account is funded.
FSAs are use it or lose it accounts
What happens to funds an employee has in an Health Savings Account (HSA)
Funds are always owned by employee and transfer with employee upon termination.
Section 125 Cafeteria Benefits Plans require written document plans. what is the document required to contain?
-Description of benefits available — A specific description of each of the benefits available under the plan, including the periods during which the benefits are provided
■ Rules governing eligibility and participation — Including exclusions to the plan
■ Procedures for participant elections — Including the period during which elections may be made, the extent to which elections are irrevocable, and the periods for which elections are effective
■ Manner in which employer contributions made — Such as by a salary reduction agreement between the participant and the employer or by nonelective employer contributions to the plan
■ Maximum employer contributions — The maximum amount of employer contributions available to any participant under the plan
■ Plan year on which plan operates — If the plan year changes at any point, an amendment must be made
What are the two methods for reporting “Maximum employer Contributions” in the written plan documents required by section 125 plans?
■ Maximum dollar amount or percentage — The maximum dollar amount or maximum percentage of compensation that may be contributed as elective contributions by employees
OR
■ Method for determining maximum — The method for determining the maximum amount or percentage of elective contributions that employees may make under the plan
What are the key differences under Section 125 Cafeteria Plans considering the choice between
Cash or Taxable Benefits
or
Qualified (nontaxable) Benefits
■ Cash or taxable benefits
* Current compensation (including salary reduction)
* Payment for annual leave, sick leave or other paid time off
* Severance pay
* Property
* Employer — Provided benefits that are taxable to the employee (e.g., group term life insurance over $50,000)
* Certain after-tax employee contributions
■ Qualified (nontaxable) benefits — Under Section 125, qualified benefits are:
* Not taxable to the employee
* Tax deductible to the employer
* Cafeteria plan qualified benefits include:
* Accident or health insurance — medical, dental, vision, prescription drug, disability (STD and LTD) and accidental death & dismemberment (AD&D)
* Group life insurance up to $50,000 (amounts over $50,000 taxable under Section 79)
* Flexible spending accounts
* Health-care spending accounts
* Dependent care spending accounts
* Contributions to a 401(k) plan
* COBRA premiums
* Adoption assistance programs
* Contributions to health savings accounts
* Contributions to certain plans maintained by educational organizations
What are Prohibited benefits which can not be included in a section 125 Cafeteria Plan?
■ Athletic facilities (onsite employee facilities)
■ De minimis (minimal) benefits
■ Deferred compensation
■ Educational assistance
■ Employee discounts
■ Lodging on employer premises
■ Long-term care insurance
■ Meals
■ Moving expenses
■ Scholarships or fellowships
■ Transportation benefits
Define the limits of the 3 types of nondiscrimination testing rules for Section 125 Plans.
Eligibility Test
Benefits Test
Concentration Test
■ Eligibility test — 70% of non-HCIs must be eligible.
* Does the plan discriminate in favor of HCIs concerning their ability to participate?
■ Benefits test — Cannot discriminate in favor of HCIs with respect to availability or selection
* Does the plan discriminate in favor of HCIs concerning:
– Contributions made to the plan
– Benefits received under the plan
■ Concentration test — A maximum of 25% of the tax-favored benefits provided under the plan can go to key employees.
* Does the plan discriminate in favor of key employees concerning:
– The aggregate percentage of nontaxable benefits offered to key employees vs. the
aggregate percentage of nontaxable benefits offered to all employees
Define IRC Section 129 Dependent Care Assistance
Section 129 excludes the amounts an employer provides employees in the form of dependent care assistance from gross income. It also contains rules on the establishment of a dependent care
reimbursement plan.
How is a HCE defined under IRC 129 - Dependent Care Assistance?
Highly compensated employee (HCE) — Under Section 129, a highly compensated employee is defined as someone who may have the following traits:
* Makes more than $80,000 per year
* Is in the top 20 percent of the company’s ranked annual compensation
* Owns more than 5% of the company’s stock profits
What are the IRC 129 - Dependent Care Assistance nondiscrimination rules?
Eligibility
Benefits Test
Average Benefits Test
- Eligibility test — 70% of non-HCEs must be eligible.
- Benefits test — Benefits provided cannot favor HCEs.
- Average benefits test — Average benefits provided to NHCEs are at least 55% of the average benefits provided to HCEs.
What are the consequences of failing to meet nondiscriminatory testing under IRC Section 129 Dependent Care?
If the plan is discriminatory, HCE is taxed on the entire benefit.
Which of the following best defines cafeteria plans?
A. Plans that allow employees to choose between cash and one or more qualified benefits
B. Plans that allow employees to choose between equity and cash benefits
C. Plans that allow employees to choose from a limited number of benefits packages
D. Plans that allow employees to choose between cash and one or more nonqualified benefit
A. Plans that allow employees to choose between cash and one or more qualified benefits
Which one of the following is a statutorily eligible benefit under Section 125?
A. Severance pay
B. COBRA premiums
C. Educational assistance
D. De minimis (minimal) benefits
B. COBRA premiums
Which of the following statements is most accurate regarding Section 125 plans?
A. An employee’s spouse or dependent can make selections at any time.
B. Self-employed and independent contractors are able to participate in the plan.
C. If benefits are self-insured, state insurance laws apply.
D. Elections are required prior to the beginning of the plan year, except for a change in status.
Which of the following benefits are prohibited from inclusion in a Section 125 cafeteria plan?
A. Health plans
B. Group life insurance
C. Long-term care insurance
D. Vision plans
C. Long-term care insurance
What are three primary nondiscrimination tests that ensure cafeteria plans do not discriminate in favor of highly compensated employees or key employees?
A. Eligibility, benefits and executive tests
B. Eligibility, benefits and concentration tests
C. Eligibility, executive and concentration tests
D. Benefits, executive and concentration tests
B. Eligibility, benefits and concentration tests
For Section 129, what nondiscrimination test is used along with the eligibility and benefits tests?
A. Concentration test
B. Executive test
C. Shareholder test
D. Average benefits test
D. Average benefits test
