A Cafeteria Plan is a benefit provided by the employer which allows employees to contribute a certain amount of gross income to a designated flexible spending account (FSA) or accounts before taxes are calculated. Subject to employer plan design, these funds can be used for medical or other expenses not covered by insurance, dependent care, and a host of other allowable items. Access to the deferred funds is accomplished either by reimbursement throughout the plan year or claim period, or by way of a debit card provided to the employee.
For federal income tax withholding purposes, a cafeteria plan allows employees to reduce their taxable gross income. Additionally, for both employers and employees, amounts deferred into an FSA are not subject to either Medicare or Social Security (FICA) taxes.
For employers, the FICA tax savings almost always pays the total cost of having a first-class third party administrator manage a comprehensive cafeteria plan that features everything imaginable.
For employees, from all tax savings sources, there is an approximate savings of between 22% and 42% of every dollar they contribute to the plan, since employee gross income is reduced by the amount placed in a cafeteria plan account. This tax savings results in a higher net income.
As an example, let’s say an employee's adjusted monthly salary is $3,000, with total tax deductions of $750 per month. In this example, take-home pay is $2,250. If the employee's unreimbursed medical and dependent care expenses come to $400 per month, then the employee's net income is $1,850. However, if the employee deposits that same $400 per month into an FSA, then his taxes are reduced by $100, leaving the employee's net pay of $1,950 – or $1,200 more per year!
In addition to benefiting from the tax savings, another employee benefit is the “cash flow” increase built into the FSA. Under what are known as "uniform coverage rules", no matter how much money employees have actually contributed to the plan at any given point, they can still be reimbursed up to their entire annual election. So a major medical expense at the beginning of the claim period can be reimbursed even though few, if any, deposits have been made into the account at that time. This applies to the medical portion of the FSA only; other eligible expenses such as dependent care benefits are not eligible under uniform coverage rules.
The various expenses that can be reimbursed with an FSA may have annual limits imposed either by the employer in its plan design, or by federal regulations.
Some employers subject their employees to what is known as the "use it or lose it" rule. This means that whatever an employee elects to set aside into his FSA during his plan year must be either spent on the items elected by the employee or forfeited altogether. However, many employers design their plans to allow for some of an employee's unused funds to be rolled over to the succeeding benefit period, or to allow a grace period for employees to spend unused funds during the succeeding benefit period. TPA Systems has the ability to administer any of these cafeteria plan design options.
Subject to plan design by the employer, expenses which can be paid for with cafeteria plan deductions are specified in Section 213(d) of the Internal Revenue Code. To view 213(d), click below.