The recently passed healthcare reform bill amends Section 125 of the Internal Revenue Code (the “IRC”) to allow small employers to establish “simple cafeteria plans” for plan years beginning after December 31, 2010. If an eligible small employer satisfies the eligibility and contribution requirements discussed below, the employer can take advantage of a safe harbor from the nondiscrimination rules of Section 125. This means that these plans plan will be deemed to not discriminate in favor of highly compensated participants or key employees.
Who Is an Eligible Employer?
An eligible employer is an employer with an average of 100 or fewer employees during either of the two preceding years. To meet this requirement, a year can only be taken into account if the employer was in existence throughout the year. An employer who was not in existence throughout the previous year must base this determination on the average number of employees it reasonably expects to employ in the current year.
In addition, once an employer meets this eligibility requirement and establishes a simple cafeteria plan for any year, the employer will continue to be treated as an eligible employer for subsequent years, until its average number of employees reaches 200 or more.
What Are the Minimum Eligibility and Participation Requirements?
Eligible employees are those who are credited with at least 1,000 hours of service for the preceding year. However, the employer may choose to exclude:
- Employees who have not attained age 21 before the close of the plan year
- Employees who have less than 1 year of service with the employer as of any day during the plan year
- Employees who are covered under a collective bargaining agreement in which cafeteria plan benefits were the subject of good faith bargaining
- Nonresident aliens working outside the United States
Once an employee is eligible, he or she must be permitted to elect any benefit available under the plan, subject to any terms and conditions that are applicable to all participants.
What Are the Contribution Requirements?
To establish a simple cafeteria plan, an employer must make a contribution on behalf of every “qualified employee,” whether or not the qualified employee makes a salary deferral to the plan. A “qualified employee” includes any employee who is eligible to participate in the plan and who is not a highly compensated employee or a key employee (as those terms are defined in the IRC).
The contribution may equal either:
- a uniform nonelective employer contribution equal to at least 2% of each qualified employee’s compensation; or
- an amount not less than the lesser of:
- 6% of the qualified employee’s compensation for the plan year; or
- a matching contribution equal to twice the amount of the salary reduction contributions of each qualified employee.
If an employer decides to provide the matching contribution, it cannot provide a matching contribution to highly compensated or key employees at a rate greater than the matching contribution it provides to all other employees.
The employer must use the same method to calculate the minimum contribution for all nonhighly compensated employees.
In addition, an employer can make contributions to provide additional qualified benefits under the plan, as long as the above requirements are met. A qualified benefit is pretax benefit under a specific provision Section 125 of the IRC, such as accident and health benefits, adoption assistance, dependent care assistance, group-term life insurance coverage and health savings accounts. Long-term care insurance, however, is not a qualified benefit.
Which Nondiscrimination Testing Is Treated as Being Met?
Once an employer meets the contribution and eligibility requirements above, the plan is treated as meeting certain applicable nondiscrimination testing. For example, an employer does not have to satisfy the “eligibility,” “contributions and benefits” and “key employee concentration” testing requirements of IRC sections 125(b)(1)(A), 125(b)(1)(B), and 125(b)(2), respectively. In addition, the nondiscrimination requirements for group term life insurance in IRC section 79(d), the requirements for self-insured medical expense reimbursement plans in Section 105(h), and the dependent care assistance requirements in IRC section 129(d) paragraphs (2), (3), (4), and (8) are also treated as satisfied if such benefits are provided through the simple cafeteria plan.
Because of the safe harbor afforded by the simple cafeteria rules, eligible employers may save on the administrative costs typically incurred in conducting nondiscrimination testing. In addition, small employers who otherwise would not pass testing due to the lack of utilization by non-key and non-highly compensated employees will be able to establish cafeteria plans to enable their employees to use pre-tax dollars to purchase cafeteria plan benefits such as medical, vision and dental coverage.