In a quandary about owners and key employees who can’t fully participate in employer cafeteria plans? Cafeteria plan nondiscrimination tests sometimes prohibit owners and key employees from participating in these plans.
I’ve been asked over and over how to maximize non-taxable benefits to owners and key and highly compensated employees. The solution may be as simple as a SIMPLE cafeteria plan. This type of cafeteria plan is simple for employers to establish and maintain.
With a SIMPLE cafeteria plan, employers can skip all the applicable nondiscrimination testing requirements associated with today’s cafeteria plans, assuming it:
- Meets certain employer size requirements;
- Passes the SIMPLE plan’s eligibility and participation requirements; and,
- Provides a required contribution.
First I’ll discuss what constitutes an eligible employer and then move on to the eligibility, participation, and contribution requirements. Then, as we go through some examples, you may see how C-Corporations can provide additional non-taxable benefits to owners and key employees. A SIMPLE plan will be a snap for some of your employers. Let’s look at the facts.
Eligible Employer
SIMPLE plans are for “small” employers. This means employers who employed 100 or fewer employees during either of the two preceding years. If employers have not been in existence for two years, they base their calculations on the average number of employees reasonably expected to be employed on business days in the current year. Employers are required to have a working payroll that fits around their potential employees. Some small employers find that with the help of One Click Accountant or a similar accounting service they will need to be aware of the type of employees they will need for their business.
Employers must count employees under common ownership rules, part-time and seasonal employees, and leased employees.
Eligible employers that grow to more than 100 employees after establishing a SIMPLE plan can retain their eligibility to maintain the plan until they employ an average of 200 or more employees on business days during the year. That doesn’t mean they have to abandon their SIMPLE plan in the middle of a plan year. They can finish out the current plan year, but then must revert to a regular cafeteria plan-with nondiscrimination testing-starting with the subsequent plan year.
Although regulations prohibit a sole proprietor, partner in a partnership, member of an LLC (in most cases), or individuals owning more than two percent of an S-Corporation from participating in a cafeteria plan, they may still sponsor a SIMPLE plan. These “owner/employees” still benefit from the savings on payroll taxes and, in some cases, workers’ compensation premiums. Also, these types of entities may have key or highly-compensated employees that can benefit from a SIMPLE plan. Shareholders of regular C-Corporations may participate in the SIMPLE cafeteria plan.
Eligibility and Participation Rule
SIMPLE plans must allow all employees with at least 1,000 hours of service for the preceding year to participate in the plan and each eligible employee must have the right to elect any benefit offered under the plan.
There are some employees that may be omitted from participating in the plan. Those that are under the age of 21, less than one year of service, covered by a collective bargaining agreement, or nonresident aliens working outside of the United States.
Required Employer Contributions
Required employer contributions can be delivered through the plan by one of two methods.
Non-Elective:
Provide an amount equal to a uniform percentage of not less than two percent of employees’ compensation for the plan year. This amount is made available to all eligible employees, even if they do not make any salary deductions.
Matching:
Contributions may be the lesser of twice the amount of employees’ salary reductions or 6 percent of employees’ compensation for the plan year.
Employer contributions must be available to be used for any qualified benefit offered through the plan, but cash need not be offered for these required employer contributions. The employer contributions cannot be made to highly-compensated or key employees at a greater rate than to the rank and file employees.
Non-Discrimination Tests
What does all this “buy” the employer? In addition to some serious payroll tax savings, there’s no more complicated and confusing nondiscrimination testing associated with offering a cafeteria plan.
The tests avoided include four tests for the healthcare flexible spending account (FSA) and four tests for the dependent care account; plus the cafeteria plan code section carries another three tests that employers are obliged to complete and pass every plan year. The employer may also have to make adjustments to elections if one or more nondiscrimination test fails.
Two of the tests that are failed more often than any others are the dependent care 55 percent Concentration Test and the overall 25 percent Concentration Test that includes all benefits incorporated into the cafeteria plan. Let’s work through one example to see how the 25 percent Concentration Test works and how the implementation of a SIMPLE cafeteria plan can benefit owners and key employees.
In the example below there are two owners and nine other employees. The owners elect $19,600 and six (NHC) employees elect $26,000 salary reductions to the plan. These amounts include premiums for employer-provided health coverage, dependent care, and healthcare FSA.
This scenario would not pass the 25 percent Concentration Test. $19,600 divided by $45,600 equals 43 percent of total benefits going to key employees. In order to pass, the owners would have to reduce their elections to about $8,700. One owner would lose the $5,000 pretax benefit from the dependent care portion of the plan because the plan would not pass all the dependent care nondiscrimination tests.
By establishing a SIMPLE cafeteria plan, employers need not perform any discrimination tests and the owners could take advantage of substantial employer contributions.
Table 1 illustrates the contribution options this employer may pursue. In this example the employer could choose between contributing two percent of compensation to the SIMPLE plan for all eligible employees, or contributing an amount equal to six percent of compensation for participating employees.
In addition, this employer previously paid 50 percent of the group health insurance premiums. Employer contributions to the SIMPLE cafeteria plan will take the place of employer group health insurance premiums in the amount of $27,600.
And don’t forget-if participants don’t spend all their money, it can be forfeited back to the employer to offset administrative expenses. By forfeiting unused contributions, the employer’s net costs could be reduced further.
This employer could make a contribution to the plan of six percent of compensation and provide the two owners with $24,000 and the six non-highly compensated employees $18,000. The employer was previously paying $27,600 for health insurance premiums. Their outlay, considering the premiums they used to pay, would be $14,400, and that is not taking into consideration the FICA savings. For a cost of $14,400, $24,000 goes directly to them.
It’s All in the Numbers
For small or family-owned C-Corporation businesses, a SIMPLE cafeteria plan may be just the ticket to maximize benefits to owners and key employees. For larger companies, it may make sense to establish a SIMPLE plan in order to pass all the nondiscrimination tests and preserve non-taxable benefits to owners and key and highly-compensated employees.
The information contained in this article is not intended to be legal, accounting, or other professional advice. We assume no liability whatsoever in connection with its use, nor are these comments directed to specific situations.
