Employees who participate in a cafeteria plan may experience the following advantages and disadvantages.
Advantages for Employees
The extent of an employee’s advantages arising from cafeteria plan participation will depend on the employee’s tax status, the amount of his or her taxable income and pre-tax salary reduction elections, the scope of state and local laws, and the cafeteria plan’s features.
No Federal Income Tax
Employees do not have to pay federal income tax on salary reduction amounts to a cafeteria plan-employees can buy qualified benefits with pre-tax dollars. And if a plan with employer contributions offers a cash-out option, employees who take health coverage or other benefits instead of cash will not be taxed on the cash that they could have received (but chose not to receive).
No FICA, FUTA, or RRTA Tax
There are no Social Security and Medicare (FICA) taxes, federal unemployment (FUTA) taxes, or Railroad Retirement Tax Act (RRTA) taxes on pre-tax salary reductions under a cafeteria plan. FICA, FUTA, and RRTA wages do not include any payment made to, or on behalf of, an employee or his or her beneficiary under a Code §125 cafeteria plan, if (1) the payment would not be treated as wages without regard to the plan; and (2) it is reasonable to believe (if Code §125 applied) that Code §125 would not treat any wages as constructively received.
State and Local Taxes
Most state and local governments treat cafeteria plan elections favorably for state and local income tax purposes. States vary as to how they treat cafeteria plan elections for purposes of state unemployment compensation taxes and workers’ compensation taxes (e.g., some states do not recognize cafeteria plan salary reductions, and they base such taxes on gross pay before cafeteria plan salary reductions).
Plan Administrators should check with their state and local tax authorities to determine the status of cafeteria plan contributions in their jurisdictions.