Cafeteria Plans

A cafeteria plan is a written plan that allows your employees to choose between receiving cash or taxable benefits instead of certain qualified benefits for which the law provides an exclusion from wages. If an employee chooses to receive a qualified benefit under the plan, the fact that the employee could have received cash or a taxable benefit instead will not make the qualified benefit taxable.

Generally, a cafeteria plan does not include any plan that offers a benefit that defers pay. However, a cafeteria plan can include a qualified 401(k) plan as a benefit. Also, certain life insurance plans maintained by educational institutions can be offered as a benefit even though they defer pay.

Qualified benefits. Qualified benefits include the following benefits discussed in section 2.

• Accident and health benefits (but not medical savings accounts or long-term care insurance).
• Adoption assistance.
• Dependent care assistance.
• Group-term life insurance coverage (including costs that cannot be excluded from wages).

Benefits not allowed. A cafeteria plan cannot include the following benefits discussed in section 2.

• Archer medical savings accounts.
• Athletic facilities.
• De minimis (minimal) benefits.
• Educational assistance.
• Employee discounts.
• Lodging on your business premises.
• Meals.
• Moving expense reimbursements.
• No-additional-cost services.
• Scholarships and fellowships.
• Transportation (commuting) benefits.
• Tuition reduction.
• Working condition benefits.

It also cannot include scholarships or fellowships (discussed in Publication 520, Scholarships and Fellowships).

Employee. For these plans, treat the following individuals as employees.

1. A current common-law employee (see Circular E for more information).
2. A full-time life insurance agent who is a current statutory employee.
3. A leased employee who has provided services to you on a substantially full-time basis for at least a year if the services are performed under your primary direction or control.

Exception for S corporation shareholders. Do not treat a 2% shareholder of an S corporation as an employee of the corporation. A 2% shareholder for this purpose is someone who directly or indirectly owns (at any time during the year) more than 2% of the corporation's stock or stock with more than 2% of the voting power.

Plans that favor highly compensated employees. If your plan favors highly compensated employees as to eligibility to participate, contributions, or benefits, you must include in their wages the value of taxable benefits they could have selected. A plan you maintain under a collective bargaining agreement does not favor highly compensated employees.

A highly compensated employee for this purpose is any of the following employees.

1. An officer.
2. A shareholder who owns more than 5% of the voting power or value of all classes of the employer's stock.
3. An employee who is highly compensated based on the facts and circumstances.
4. A spouse or dependent of a person described in (1), (2), or (3).

Plans that favor key employees. If your plan favors key employees, you must include in their wages the value of taxable benefits they could have selected. A plan favors key employees if more than 25% of the total of the nontaxable benefits you provide for all employees under the plan go to key employees. However, a plan you maintain under a collective bargaining agreement does not favor key employees.

A key employee during 2002 is generally an employee who is either of the following:

1. An officer having annual pay of more than $130,000.
2. An employee who for 2002 was either of the following:
1. A 5% owner of your business.
2. A 1% owner of your business whose annual pay was more than $150,000.

Form 5500. If you maintain a cafeteria plan, you must report information about the plan each year by the last day of the 7th month after the plan year ends. Use Form 5500, Annual Return/Report of Employee Benefit Plan, and Schedule F (Form 5500). See the form instructions for information on extensions of time to file.

More information. For more information about cafeteria plans, see section 125 of the Internal Revenue Code and the related regulations.

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