To answer your questions on new cafeteria plan regulations, we've asked our expert, Scott Sims, a legal consultant in Hewitt's Health Management Practice, to respond with the most current developments. If you'd like to ask a question regarding these new regulations or on any pressing human resources challenges you might be facing, email us, and we'll share responses to select questions on a regular basis.

As an employer, you know how important your cafeteria plan is to the success of your employee benefit program. Cafeteria plans are used for everything from allowing employees to pay for their benefits on a pretax basis to funding health care and dependent care spending accounts. That's why, as the sponsor of a cafeteria plan, you will need to comply with the IRS rules to preserve the employer and employee tax advantages of your cafeteria plan.

As you may know, the Internal Revenue Service issued new cafeteria plan regulations that are generally effective January 1, 2009. The new rules clarify and significantly expand on the existing rules prohibiting your cafeteria plan from discriminating in favor of highly paid employees. In addition, the new regulations confirm a cafeteria plan must be in writing and add a number of new provisions that employer must include in their written plan. With the deadline for compliance looming, are you ready?

Question: What are the nondiscrimination requirements under the regulations, and what types of plan designs are likely to violate the new rules?

Answer: The new rules generally provide:

• The cafeteria plan must benefit a minimum percentage of nonhighly compensated employees.
  
• All employees covered by the plan must have the same right to benefits under the plan on the same terms.
  
• Highly compensated employees cannot use a disproportionate amount of the plan benefits.
  
• All benefits provided through the plan must be nondiscriminatory.

If a cafeteria plan fails the nondiscrimination testing requirements, all highly compensated employees will be taxed on their benefits elected through the plan. If any of the benefits provided through the plan (self-funded health, dependent care FSA, or group term life) are discriminatory, then all highly compensated employees will also be taxed on the discriminatory benefit.

The following plan design features are cause for concern under the nondiscrimination rules:

• When an employer with a single cafeteria plan varies waiting periods, employment requirements, or entry dates.
  
• When an employer covers employees of one division or subsidiary, but not other employees of the company.
  
• When an employer excludes part-time, seasonal, temporary, or hourly employees from the cafeteria plan.
  
• When an employer with a single cafeteria plan varies benefits or benefit contributions for different groups of employees.
  
• When the cafeteria plan bases employer contributions based upon a percentage of compensation or years of service.
  
• When an employer maintains two separate cafeteria plans, one for a group of employees consisting of highly paid individuals and the other for lower paid rank and file employees.
  

Question: What are the written plan requirements under the new regulations?

Answer: The new regulations confirm that a cafeteria plan must be in writing, and must be operated in accordance with its terms. If either requirement is not satisfied, the entire plan can lose its tax preferred status and all participants could be taxed on their elections under the plan. The new regulations significantly expand the requirements of what must be included in the plan document to be a valid cafeteria plan. The written plan must:

• Describe all benefits
  
• Clearly state the eligibility requirements and the procedure for making elections and to the extent a plan allows for mid-year changes in election, the rules for making mid-year changes
  
• Describe how contributions may be made to the plan
  
• State the plan year
  
• Provide that only employees can be covered by the plan

In addition, to the extent applicable the cafeteria plan must also:

• Describe the uniform coverage and use-or-lose if a health FSA is offered though the plan
  
• State the terms of an FSA grace period
  
• Describe the ordering rules for PTO purchased through the cafeteria plan
  
• Provide for the specific rules for making HSA contributions through the cafeteria plan including the special change in election rules that apply to HSA contributions

Question: What should employers be doing to comply with the cafeteria plan regulations?

Answer: Employers should be taking the following steps to comply with the new regulations:

• Review your written plan, and to the extent necessary, amend or completely redraft your plan so it contains all of the information required by the new regulations. In addition, employers must ensure the written plan also is consistent with their current administrative procedures.
  
• Develop annual nondiscrimination testing procedures. Since many of the nondiscrimination requirements that apply to cafeteria plan are "design" based, much of this testing should be done during the planning stages of the next plan year. Other "utilization" based tests should be performed during and at the end of the plan year.

As the status of these regulations change, we will be providing updates to our clients in a variety of formats, including this column. Stay tuned!

About Our Expert
Scott Sims is a legal consultant in Hewitt's Health Management Consulting Practice and serves on the Technical Advisory Committee of the Employers' Council on Flexible Compensation. As a thought leader in the area of consumer-driven and account-based health care, Scott provided oral and written testimony to the Internal Revenue Service on the proposed cafeteria plan regulations.