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A cafeteria plan is a funding vehicle for a welfare benefit plan. The cafeteria plan is not a welfare benefit plan. A cafeteria plan is defined by Section 125 of the IRC. A cafeteria plan allows employees to choose between cash and certain benefits.

Two items about cafeteria plans that are important to remember include:

1 Definition of wages for any plan that uses compensation as a variable. Retirement plans are permitted to base benefit accumulations or to test for nondiscrimination based upon a compensation figure that is calculated before or after cafeteria plan employee contributions. Thus, it is important for the auditor to know whether a cafeteria plan exists and how compensation is defined in the plan.

2 Certain cafeteria plan benefits are ERISA plans. For example, a medical flexible spending account or a health savings account could be part of an ERISA plan. A dependent care flexible spending account generally would not be an ERISA plan. If the plan under audit is the employer’s health plan, depending upon the plan’s terms, the scope of the audit may include the activity of the cafeteria plan accounts.

Cafeteria plans are subject to a special rule when it comes to the requirement that plan assets be held in trust and, thus, funded. ERISA generally treats participant contributions as plan assets. Where a plan has assets, ERISA generally requires that such assets be held in trust. The current tax rules, however, require that cafeteria plan contributions be subject to a use-it-or-lose-it rule. This means that if the participant does not spend his or her cafeteria plan contribution by the end of the year, the employer gets to keep the money. These two rules are incompatible and the DOL has granted relief from the requirement to hold cafeteria plan contributions in trust.⁸ Similarly, the DOL has granted limited relief from the trust requirement for health savings accounts.⁹

It is important to note that the IRS issued updated proposed regulations governing cafeteria plans in 2007. As of the date of this publication, these regulations had not yet been issued in final form. The IRS, however, did issue Notice 2012-40, which permits taxpayers to rely on the proposed regulations pending the publication of final regulations. The auditor is advised to watch for future amendments in client’s cafeteria plans as these regulations become final.