TN 54 (02-11)

Citations:

Social Security Act, Sections 203(f)(5)(C), 209(a)(4)(I), and 1612(a)(1)(A);

20 CFR 404.429(c), 404.1053, and 416.1110(a)

A. Definitions of cafeteria benefits plans

This section defines terms under the provisions of Section 125 of the Internal Revenue Code (IRC) or Internal Revenue Service (IRS) regulations.

1. Cafeteria plan

A cafeteria plan is a written benefit plan offered by an employer in which:

• all participants are employees; and

• participants can choose cafeteria-style, from a menu of two or more cash or qualified benefits.

2. Qualified benefits

A qualified benefit is a benefit that the IRS does not consider part of an employee's gross income. Qualified benefits include, but are not limited to:

• accident and health plans (including medical plans, vision plans, dental plans, accident and disability insurance);

• group term life insurance plans (up to $50,000);

• dependent care assistance plans; and

• certain stock bonus plans under section 401(k)(2) of the Internal Revenue Code (IRC) (but not 401(k)(1) plans).

NOTE: Cash is not a qualified benefit.

3. Salary-reduction agreement

A salary-reduction agreement is an agreement between employer and employee whereby the employee, in exchange for the right to participate in a cafeteria plan, accepts a lower salary or foregoes a salary increase.

B. Background on cafeteria benefit plans

1. IRS authority

Section 125 of the IRC permits cafeteria plans.

2. Monitoring cafeteria plans

The IRS relies on employers to ensure that IRS-approved cafeteria plans continue to meet the requirements of Section 125 of the IRC.

3. Funding cafeteria plans

Most cafeteria plans are funded by salary-reduction agreements. However, employers may contribute to fund basic benefit levels under a cafeteria plan without a salary-reduction agreement.

4. Significance of cafeteria plans for tax purposes

Because Section 125 of the IRC provides that qualified benefits and the amount of a salary-reduction agreement are not part of gross income, they are not subject to Social Security, Medicare or income taxes and are not considered income for Supplemental Security Income (SSI) purposes.

5. Cafeteria plan indicators

It can be difficult to tell whether pay slip entries represent payroll deductions, which are part of gross wages, or cafeteria-plan itemizations, which are not. The following indicators suggest a cafeteria plan:

1. A pay slip uses terms such as:

   • FLEX

   • CHOICES

   • Sec. 125

   • Cafe Plan

2. The amount of the deduction for Social Security and Medicare taxes are less than the tax rate (7.65% or 5.65% for calendar years 2011 and 2012 only) times the gross wages shown.

   EXAMPLE: A June 2010 pay slip shows $402.07 gross and $26.73 withheld for Social Security and Medicare taxes, but 7.65% of $402.07 is $30.76. Wages for SSI purposes are likely to be less than $402.07.

   NOTE: Another reason the Social Security and Medicare tax may be less than expected is that part of the gross wages may not be covered wages for title II purposes. Examples include:

   • earnings from noncovered employment,

   • wages excluded from coverage because of quarterly or calendar-year minimums; in such areas as agricultural labor, domestic employment, etc., and

   • wages excluded from coverage because they are above the yearly maximum.

3. An S2 State-wage-match alert shows a discrepancy between State wage data and the verified wage data on the Social Security Record (SSR).

C. Policy for cafeteria benefit plans

1. General cafeteria plan

A plan is not a cafeteria plan unless it meets the requirements of Sec. 125 of the IRC.

2. Salary reduction agreement

Amounts used to purchase qualified benefits under a cafeteria-plan with a salary-reduction agreement are not the employee's wages and are not considered income for SSI purposes. Most pay slips do not reflect that a salary-reduction agreement exists.

3. Employer contributions, no salary-reduction agreement

Amounts an employer contributes to fund basic benefit levels under a cafeteria plan without a salary-reduction agreement are not the employee’s wages and are not considered income for SSI purposes. See example in SI 00820.102E.3. in this section.

4. Payroll deductions

An employee may use payroll deductions to purchase cafeteria-plan benefits in addition to, or instead of, cafeteria plan benefits provided under a salary-reduction agreement or employer contribution. For example, employees who want more than basic benefits may pay additional costs through voluntary payroll deductions. The amounts of those voluntary payroll deductions are the employee's wages and are considered earned income for SSI purposes. Unless an exception applies, FICA will be deducted from these payroll deductions.

IMPORTANT: Pay slips that appear to show payroll deductions may actually show how funds from a salary-reduction agreement are allotted among qualified benefits.

5. Cash received under a cafeteria plan

a. In lieu of benefits

Cash received under a cafeteria plan in lieu of benefits is considered wages for SSI purposes.

b. Reimbursement for expenses

Payment received for reimbursement of a qualified-benefit paid by the employee; e.g., child care, is not considered income for SSI purposes.

6. Qualified benefits for SSI purposes

Qualified benefits are neither earned nor unearned income for SSI purposes.

D. Procedure for cafeteria benefit plans

1. Assumption of cafeteria plan compliance

Unless you become aware that the IRS has determined otherwise, assume, absent evidence to the contrary, that a cafeteria plan complies with IRS requirements, and that the employer correctly classified payments as either wages or qualified benefits under a salary reduction agreement.

2. How to develop cafeteria plan precedents

If a precedent is needed, per SI 00820.102D.3. in this section, contact the appropriate human resource or accounting office of the employer (by phone, if possible) and ask if the employer offers a cafeteria plan. Proceed as follows:

a. Employer does not offer a cafeteria plan

Prepare and retain in field office (FO) files a precedent showing:

• employer name, address, and phone number; and

• name, title of person contacted and date of contact; and

• a statement that the employer does not offer a cafeteria plan.

b. Employer offers a cafeteria plan

Ask the employer to forward a copy of its employee-benefits package given to new employees, which explains its particular cafeteria plan.

Prepare and retain in FO files a precedent showing:

• employer name, address, and phone number;

• name, title of person contacted and date of contact;

• effective date of the plan;

• employee positions covered by the plan;

• benefits offered under the plan;

• which deductions on the pay slips are nontaxable; and

• any additional information needed to determine chargeable gross wages from pay slips.

NOTE: Update precedents periodically, and secure updates or revisions to the employee benefits package since the last contact. Updating precedents is critical to ensure accurate wage determinations involving cafeteria plans.

3. Case development and documentation for cafeteria plans

Apply the following steps to:

• decide whether cafeteria-plan development is needed and, if so,

• establish whether a cafeteria plan is involved and, if so,

• determine chargeable wages.
  

REMINDER: Most cafeteria plans have a salary reduction agreement. However, there are instances when an employee uses payroll deductions to purchase cafeteria-plan benefits in addition to, or instead of, cafeteria plan benefits provided under a salary-reduction agreement or employer contribution. If the paystub indicates there are voluntary contributions, determine the benefits offered under the employer’s cafeteria plan and what benefits were provided through voluntary employee contributions. Treat the amount of the employee’s contributions under a cafeteria plan as wages, per SI 00820.102C.4. in this section.

NOTE: It is not necessary to separately document responses to the questions in the following chart, except where indicated.

E. Examples of cafeteria plans

1. Employee chooses not to join a cafeteria plan

ABC, Inc. offers a cafeteria plan funded through a salary-reduction agreement. An employee who decides not to participate receives cash equal to or less than the amount the employer would have contributed as a premium on behalf of the employee. Mr. Green takes the cash. The cash is part of Mr. Green’s wages.

2. Salary reduction under cafeteria plans

Mr. Black has the option of accepting a $100-a-month raise or participating in a cafeteria plan by entering into a salary-reduction agreement and allowing his employer to use the $100 to help fund the plan. He enters into the salary-reduction agreement. The $100 is not part of Mr. Black’s wages.

3. No salary reduction, but contributions allowed under cafeteria plans

The XYZ Company contributes $50 a week to fund basic benefit levels under a cafeteria plan that offers cash and a variety of insurance coverages. There is no salary-reduction agreement.

Employees who want more than the basic benefits, may pay the additional cost through voluntary payroll deductions.

Example: Mrs. Grey chooses health insurance and life insurance costing $83 per week. XYZ's $50 contribution is not wages. The $33 that Mrs. Grey contributes voluntarily is part of her gross wages.

NOTE: An employer's contribution to a cafeteria plan is not income whether or not there is a salary-reduction agreement.

4. Cash in lieu of benefits under cafeteria plans

Same background as in SI 00820.102E.3. in this section. Mr. Brown selects insurance that costs $35 a week and opts for a weekly cash payment of $15 in lieu of additional coverage. XYZ's $35 contribution is not part of Mr. Brown’s wages, but the $15 cash payment is.

5. Cash as reimbursement for cafeteria plan-approved expenses

Same background as in SI 00820.102E.3. and SI 00820.102E.4. in this section. Mrs. White selects insurance that costs $30 a week and childcare benefit that cost $20 a week. Neither XYZ's contribution nor the reimbursements of childcare costs is considered part of Mrs. White’s wages.

6. Cafeteria plan with no salary reduction, voluntary employee contribution

The ABC Company contributes $10 a week to fund basic benefit levels under a cafeteria plan that offers a variety of insurance coverages. There is no salary-reduction agreement. The June 2009 pay stubs reflect a deduction for FICA taxes that does not equal 7.65 percent of the gross wages and shows a $16 voluntary deduction for cancer insurance. To clarify what comes under the cafeteria plan and the plan limits, contact the employer. The employer confirms that they participate in a cafeteria plan and that the pre-tax deduction of $10 is for cancer insurance. The $10 that the employer contributes under a cafeteria plan is not wages. Also, the employer confirmed that the employee wanted more than the basic benefits, and that the employee pays an additional $6 through voluntary payroll deductions. The employee’s contribution of $6 is countable gross wages.

F. References

• RS 01402.030 through RS 01402.036, Treatment of Cafeteria Plans for Title II Purposes

• RS 01402.038, Tax-Favored Health Plans

• RS 01402.010, Salary-Reduction Agreements

• SM 01601.910, Remarks Date – RMKS

• SI 00820.100, Wages – General

• SI 00820.130, Evidence of Wages or Termination of Wages

• GN 00301.285, Statements and Other Documentation

• GN 00301.286, Electronic Evidence Documentation and Retention

• GN 00301.288, What Information is Needed on EVID and DROC in PE Situations to Identify the Type of Evidence Submitted.

G. Exhibit – SSI cafeteria plan worksheet

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