Plan Now to Review and  Make Revisions to Written Plans

At long last, the IRS has issued a new set of coordinating proposed regulations that

Qualified Benefit Examples     In general, in order for a benefit to be a qualified benefit for purposes of Section 125, the benefit must be excludible from employees' gross income under the tax code and must not defer compensation, unless specifically allowed.     Examples of qualified benefits include: Group-term life insurance on the life of an employee. Employer-provided accident and health plans, including health flexible spending arrangements. Accidental death and dismemberment policies. A dependent care assistance program. An adoption assistance program. Contributions to a 401(k) plan. Contributions to certain plans maintained by educational organizations, and contributions to Health Savings Accounts (HSAs). Long-term and short-term disability coverage as a qualified benefit. Non-Qualified Benefit Examples     A cafeteria plan must not offer any of the following benefits: Scholarships. Employer-provided meals and lodging. Educational assistance. Long-term care insurance or services. (However, an HSA funded through a cafeteria plan may be used to pay premiums for long-term care insurance or services.) Group term life insurance for an employee's spouse, child or dependent.

What Must Be in Writing     Under the new proposed regulations, an employer's written plan must: Specifically describe all benefits. Set forth the rules for eligibility to participate and the procedure for making elections. Provide that all elections are irrevocable (unless allowed under the tax code). State how employer contributions can be made (for example, salary reduction or non-elective employer contributions). Specify the maximum amount of elective contributions, and the plan year.     If the plan has an FSA, the written document must include provisions complying with the uniform coverage and the "use-it-or-lose it" rules.

consolidate the rules and provide some much-needed clarity in the operation of cafeteria plans. Employers had been relying on a series of proposed and temporary regulations dating back to 1984.

The new proposed regulations, which replace the existing regulations, are generally effective for plan years beginning January 1, 2009. However, they can be relied on by employers in the interim.

Although the proposed regulations retain many long-standing cafeteria plan rules, they clarify them and incorporate new developments, such as the use of debit cards to pay qualified expenses.

Basic Premise of Cafeteria Plans

The employer typically offers a menu of fringe benefits and cash from which employees may select. For example, an employee may choose between tax-free benefits such as the first $50,000 of group term life insurance, dependent care assistance or disability income insurance.

The employee agrees to contribute a portion of his or her salary on a pre-tax basis for the qualified benefits. Since the contributions are not actually received by the recipients, they are not considered wages for federal (and possibly state) tax purposes under Section 125 of the Internal Revenue Code, which reduces employees' income taxes and increases their take-home pay. The contributions are also not generally subject to FICA and FUTA taxes so the employee and the employer save on payroll taxes.

Furthermore, a cafeteria plan can also be used t

• Reduce deductibles and coinsurance amounts for company health and insurance plans.
• Increase maximum coverage above employer-paid amounts.
• Add certain coverage riders.

Highlights of the New Rules

Some key points in the new proposed regulations include:

Tax-free treatment - The proposed regulations emphasize that a written cafeteria plan is the sole mechanism allowed for offering a tax-free choice between cash and nontaxable fringe benefits. This was not entirely clear under previous regulations. For this purpose, fringe benefits must be exempt from tax under a specific tax code section. On the other hand, a cafeteria plan violates Section 125 if it offers a nonqualified fringe benefit such as long-term care assistance.

Discrimination testing - Under a long-standing rule, benefits provided to highly compensated employees and key employees must be reported as taxable income if the plan favors them. The new regulations impose discrimination testing requirements for eligibility, contributions and benefits. Previously, there was confusing guidance concerning the testing of discriminatory practices.

Plan requirements - The cafeteria plan must be formalized in writing and include the elements described in the right-hand box. All plan participants must be employees (although former employees may participate as long as they don't predominate). Sole proprietors, partners, corporate directors and 2 percent-or-more shareholders of an S corporation are not considered employees. Note: A cafeteria plan cannot be used as a vehicle for deferred compensation. Benefits generally are required to terminate at the end of the year.

Forfeitures associated with Flexible Spending Accounts (FSAs) - After all reimbursements have been made, the amount left in an FSA can be:

• Retained by the employer.
• Used to defray expenses to administer the plan.
• Used to reduce the required salary amounts for the following plan year.
• Returned to employees "on a reasonable and uniform basis."

Elections - The election to choose a particular benefit must be made by the earlier of the first day of coverage or when benefits are first available. An election is irrevocable and cannot be revised during the year except when there is a change in status (such as marriage, divorce or birth of a child). New employees can make an election within 30 days of being hired. Note: For the first time, the regulations allow new-hires to claim benefits dating back to their hiring dates.

Health benefits - The new proposed regulations permit a cafeteria plan to pay or reimburse health and accident plan insurance premiums for an employee's individual policy.

Als The plan is permitted, but not required, to provide a 2 and 1/2 month grace period at the end of the year for coverage of FSA health care expenses. This relaxes the "use-it-or-lose-it" feature that often discourages people from signing up for FSAs. The grace period is also permitted for dependent care expenses, "but in no event does it apply to paid time off or contributions to Section 401(k) plans," according to the new rules.

These are just some of the provisions in the new proposed IRS regulations. If your company maintains a Section 125 cafeteria plan, it's a good time to consult with your tax and employee benefit advisers about whether it is advantageous to adopt any changes before 2009. In addition, you should review your plan, examine the regulations to ensure compliance by the start date, and revise written plan documents as required.