As an employer can I fringe benefit a voluntary benefit in order to reduce the employees’ tax liability?
By: Angela Cordle
As an employer can I fringe benefit a voluntary benefit in order to reduce the employees’ tax liability?
Answer: We do not know the type of fringe benefit you plan to provide your employees or whether you intend to provide it to them on a pre-tax or post (after)-tax basis, but if your goal is to reduce your payroll tax liabilities and increase your employees’ take home pay, then you will need to provide the benefit on a pre-tax basis through a flexible benefit (Flex), or cafeteria plan. While some insurance brokers may be familiar with Flex plans, these plans involve complex tax rules and should not be implemented without consulting a tax advisor who specializes in employee benefits. Flex or cafeteria plans are authorized by Internal Revenue Code Section 125 and are often referred to as Section 125 plans. To clarify whether the fringe benefit you plan to provide your employees could be offered under a Section 125 plan and develop a better understanding of the tax treatment of Section 125 plans in general, you will need to speak your lawyer, tax advisor or CPA.
From a general business perspective, flexible benefit (Flex) or cafeteria plans generally allow employees to choose between cash compensation, tax-exempt benefits, and taxable benefits without the choice itself resulting in the inclusion of the tax-exempt benefits in taxable income.
Under such a plan, it is possible for employers to provide employees with an additional benefit package at virtually no extra cost while reducing both the employer’s and the employees’ tax bills. Flex plans allow employers to upgrade and customize the array of benefits offered while keeping a handle on total benefit costs. Flex plans range from simple (that merely pay group insurance premiums with pretax dollars) to complex (that provide benefit credits and a choice of types and levels of benefits that may be chosen and paid for on either a pre-tax or post-tax basis).
Only certain qualified benefits are permissible under a Section 125 plan in accordance with IRS rules. For discussion with your legal and tax advisors, you can review articles on Section 125 plans below.
“WHAT BENEFITS CAN A CAFETERIA PLAN PROVIDE?
Only qualified benefits can be offered under a cafeteria plan. A benefit will be a “qualified benefit” for purposes of Section 125 of the IRC if:
The benefit (with an important exception) does not defer the receipt of compensation, and the benefit is excludable from gross income by reason of one of several specified IRC sections.
Qualified benefits include:
- Health plans (including HCSAs) (IRC Sections 105 and 106)
- Disability income plans (including long-term disability and short-term disability) (IRC Sections 105 and 106)
- Accident plans (including accidental death and dismemberment) and business travel and accident plans (IRC Sections 105 and 106)
- Dependent care assistance (IRC Section 129)
- Group-term life insurance (IRC Section 79)
- Section 401(k) plan contributions (an exception to the rule on no deferral of income)
- Paid time off buy and sell plans
- Adoption assistance plans
- Premiums for COBRA continuation coverage (if excludible under Section 106) under the accident and health plan of the employer sponsoring the cafeteria plan or premiums for COBRA continuation coverage of an employee of the employer sponsoring the cafeteria plan under an accident and health plan sponsored by a different employer
- Payment or reimbursement of employees’ individual accident and health insurance premiums
- Contributions to Health Savings Accounts (HSAs)
WHAT BENEFITS CAN A CAFETERIA PLAN NOT PROVIDE?
Regardless of whether such benefits are purchased with after-tax employee contributions, the following benefits are “nonqualified benefits” and may not be offered in a cafeteria plan:
- Archer medical savings accounts (IRC Section 220)
- Group term life insurance on the life of any individual other than the employee (e.g. employer-provided dependent life insurance benefits)
- Benefits under qualified tuition reduction programs (IRC Section 117)
- Educational assistance programs (IRC Section 127)
- Certain fringe benefits (IRC Section 132). Elective deferrals to Section 403(b) plans
- Long-term care insurance or services
- Employer-provided meals and lodging (Section 119)
- Health reimbursement arrangements (HRAs) that provide reimbursements up to a maximum dollar amount for a coverage period and that all or any unused amount at the end of the period is carried forward to increase the maximum reimbursement amount in subsequent coverage periods”
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