Legal Alert: IRS Issues New Proposed Cafeteria Plan Regulations

Date   Aug 15, 2007

The IRS has issued new proposed regulations relating to the administration of Section 125 cafeteria plans.


The IRS has issued new proposed regulations relating to the administration of Section 125 cafeteria plans. The new proposed regulations consolidate and withdraw prior proposed regulations and replace a temporary regulation that was previously withdrawn. The new proposed regulations generally preserve many of the rules already in place, but provide clarification on certain issues that have arisen since the prior regulations were published.

Cafeteria plans permit employees to choose between receiving taxable cash compensation or tax-free benefits such as health care, dependant care, and certain other benefits. Some of the highlights of the proposed regulations are:

  • The new proposed regulations clarify that Section 125 is the exclusive means by which an employer can offer employees a choice between taxable and nontaxable benefits without the choice itself resulting in inclusion in gross income by the employees.
  • The new proposed regulations clarify that cafeteria plans must be in writing and must be operated in accordance with written plan terms. Additionally, the 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 (except to the extent that the plan includes the optional change in status rules in §1.125-4), and state how employer contributions may be made under the plan (for example, salary reduction or nonelective employer contributions), the maximum amount of elective contributions, and the plan year.
  • The new proposed regulations permit a cafeteria plan (but not a health flexible spending account) to pay or reimburse substantiated individual accident and health insurance premiums and for COBRA premiums.
  • The new proposed regulations also provide that if the plan includes a flexible spending arrangement (FSA), the written plan must include provisions complying with the uniform coverage rule and the use-or-lose rule.
  • The new proposed regulations also provide guidance on the application of the nondiscrimination rules with regard to key employees and highly compensated individuals. The new guidance includes definitions of key terms and additional guidance on when contributions and benefits violate the nondiscrimination rules.
  • The new proposed regulations allow a written cafeteria plan to provide an optional grace period immediately following the end of each plan year, extending the period for incurring expenses for qualified benefits. A grace period may apply to one or more qualified benefits (for example, health FSA or dependent care assistance program) but not to paid time off or contributions to section 401(k) plans.

The regulations are proposed to generally apply to plan years beginning on or after January 1, 2009. According to the IRS, employers may rely on the new proposed regulations until final regulations are issued.

The IRS has requested written or electronic comments, which must be submitted by November 5, 2007. Submissions may be sent to: CC:PA:LPD:PR (REG-142695-05), room 5203, Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, Washington, DC, 20044 or electronically via the Federal eRulemaking Portal at (IRS REG-142695-05).

A public hearing on the proposed regulations has been scheduled for November 15, 2007.

If you have any questions regarding the new proposed regulations or employee benefits in general, please contact Penny Wofford, or any member of Ford & Harrison’s Employee Benefits Practice Group.