How much of your company’s employee compensation budget is allocated to fringe benefits?
In the past, this may have represented just a sliver for many C corporations, but now employee benefits often take a much larger piece of the pie. The trick is keeping costs down without hurting morale by reducing or eliminating benefits. Here is the strategy: Set up a Section 125 “cafeteria plan.” As the name implies, your company provides a menu of tax-favored fringe benefits for employees to pick and choose from. Thus, participating employees only take advantage of those benefits they truly want, helping to keep your company’s costs down. Usually, contributions to a cafeteria plan are made through a salary reduction plan. The contributions are exempt from federal income tax withholding and employment taxes. So, it’s a win-win situation for employers and employees. This is the whole story: A cafeteria plan must be a written plan maintained by an employer for employees under Section 125 of the tax code. It gives participants the opportunity to receive certain benefits on a tax-free basis. Participants in the cafeteria plan must be permitted to choose among at least one taxable benefit, such as cash, and one qualified tax-free benefit. The cafeteria plan document must specifically
describe all benefits and establish rules for eligibility and elections. This is the only way in which an employer can offer employees a choice between taxable and tax-free benefits without having the choice cause benefits to be taxable. The plan can make benefits available to employees, their spouses and dependents. It may also include coverage of former employees, but it can’t exist primarily for ex-employees. Generally, employer contributions to the cafeteria plan are made pursuant to salary reduction agreements between the employer and the employee in which the employee agrees to contribute a portion of his or her salary on a pre-tax basis to pay for the qualified benefits. Salary reduction contributions are not considered wages for federal income tax purposes. In addition, those amounts are generally not subject to FICA tax and FUTA. However, group-term life insurance exceeding $50,000 of coverage is subject to Social Security and Medicare taxes, but not FUTA tax or income tax withholding, even if it provided as a qualified benefit in a cafeteria plan. Qualified adoption assistance benefits provided in a cafeteria plan are subject to Social Security, Medicare and FUTA taxes, but not income tax. If an employee elects to receive cash instead of any qualified benefit, the payment is treated as wages subject to all employment taxes.