Cafeteria plan cut costs while adding to benefits

It may seem like a contradiction reducing payroll costs while increasing employees' benefits, but it is possible through a cafeteria plan. And at this time of year, it seems almost everyone is interested in reducing taxes.

With a cafeteria plan, employees can choose any number of benefits and, at the same time, substantially reduce their own payroll, federal and state income taxes. Cafeteria plans also provide employees the flexibility to customize their benefits to their own family situations.

So, what exactly is a cafeteria plan? A cafeteria plan, also referred to as a flexible benefit plan or Section 125 plan, is essentially a tax shelter for income used to pay for benefits and medical and dependent-care expenses.

In the case of expenses, the employee estimates the cost of certain medical and dependent-care expenses (not already covered by insurance) and arranges for this amount to be deducted over time from her paycheck. Over the year, the employee pays for those expenses with the pre-tax dollars accumulated in the cafeteria account.

Since employees' taxable salaries are reduced by the cost of the eligible benefits chosen, the employer's taxable payroll is also reduced. This can result in substantial savings on FICA taxes. In addition, a company benefits by making employees active partners in benefits planning, as is the case with a cafeteria plan. The company is taking positive steps toward cost containment.

What types of tax-saving benefits can employers offer their employees through a cafeteria plan?

Premium payments for an employer group health insurance plan.

Premium payments for an employer group term life insurance plan (up to $50,000 face amount).

Premium payments for employer group dental or vision plans.

Premium payments for an employer group long-term disability program.

Medical expenses not reimbursed.

Dental and vision expenses not reimbursed.

Dependent care expenses (up to $5,000).

Whether the owner of the entity is eligible to participate in its own cafeteria plan depends on the type of business structure the company functions under.

For instance, with an S corporation, no shareholder with a 2 percent or greater interest in the corporation is eligible to participate in the company's cafeteria plan. The shareholder's employed spouse, children, grandchildren and parents also cannot participate because of ownership attribution rules.

No partners or their employed spouses, children, grandchildren or parents in a partnership or LLC structure can participate in a cafeteria plan, either. In a sole proprietorship, all employees are eligible, but no owner is eligible. If a business operates as a C corporation, all employees are eligible for the cafeteria plan, including the owner.

The Internal Revenue Service and Employee Retirement Income Security Act have several regulations that must be complied with if a business has a cafeteria plan, including annual Form 5500 filings, various employee reports and other documentation.

If the cafeteria plan fails to meet qualifications, employees might have to file amended tax returns if the IRS rejects deferred income.

To avoid such situations, a company should consider seeking professional business advice in setting up and administering its cafeteria plan.

The good news is that the payroll tax savings a company will obtain from a cafeteria plan will cover initial set-up and administration fees of the plan within a very short time frame. Even if a company already has a benefit plan through an insurance company, it can enhance those employee benefits by adding dependent care and medical reimbursement features to its existing plan.

(Kevin Hogan, CPA, CAM, is a manager with Whitlock, Selim & Keehn LLP, a certified public accounting and business advisory firm with offices in Springfield and Branson.)