Cafeteria benefit plans: a simpler approach.

Many nursing homes today would like to set up a Section 125/Cafeteria Plan, but feel that they do not L have enough employees to do so. However, there are variations of Section 125/Cafeteria Plans that nursing homes with as few as 25 employees can set up. The simplest approach is the "premium conversion" plan.

Under the "premium conversion" plan, employees that are paying for a portion of their medical and/or dental coverage are allowed to pay with before-tax dollars. The example below illustrates this concept.

Employee Savings

Employees save because with the 125 Plan, they end up paying less federal, Social Security and state (in most states) taxes. In example I, the employees end up paying taxes on $230 per week, instead of $250 per week.

Nursing Homes Savings

Nursing homes save because they now do not have to pay matching payroll taxes on the amount that the employee pays pre-tax. The payroll tax savings include, employer-matching Social Security, workman's Compensation premiums (in some states) and federal and state (in some states) unemployment taxes. The savings to each nursing home averages approximately 10% of all employee salary reductions. That means a nursing home that collects $40,000 per year of employee contributions to the medical plan would save approximately $4,000 per year in payroll taxes.

A nursing home sponsoring a "premium conversion" Section 125/Cafeteria Plan not only saves payroll taxes, it introduces a mechanism that allows the corporation to begin to shift its employee benefits costs back to its employees, but on a tax-favored basis. As a result, future increases in employee benefits contributions are more palatable to employees because an employee's tax savings help offset any additional financial burden.

Background Of The Plan

Congress enacted Section 125 of the Internal Revenue Code in 1978. Until its enactment, if employees had an opportunity to choose between a nontaxable benefit and a taxable benefit, they would have been taxed on the amount of the benefit, even if they elected the nontaxable benefit under the principle of "constructive receipt." For example, before Section 125 was authorized, if an employee had the ability to choose between electing medical coverage or receiving cash, an employee electing medical coverage would be taxed on the benefit simply because cash was an option. Section 125 permitted an employee whose employer set up a 125 plan to elect certain eligible nontaxable benefits and not to be taxed on the amount of the benefit, even if a taxable benefit were offered simultaneously.

Corporations were initially slow to investigate the merits of Section 125, as there were no additional rulings or IRS guidance to help practitioners. Around 1982, realizing that no additional guidelines were imminent, corporations began to institute Section 125 plans based on their own interpretations of the tax code. In May of 1984, the IRS issued proposed Section 125 regulations.

The proposed regulations offered practitioners juidance on a number of key issues. One of the most important of these was that employees can elect a salary reduction to purchase permissible nontaxable benefits under Section 125. The ability to elect a salary reduction is the principle concept behind the "premium conversion" plan.

Common Misconceptions

There are a number of common misconceptions regarding "premium conversion" Section 125 Plans. Below are three of the most common ones:

"I will have additional administrative headaches"

Many nursing homes are initially concerned that setting up a Section 125/Cafeteria Plan creates additional work internally administering the plan. Under the "premium conversion" Section 125 Plan, there is no administration. The sponsoring nursing home just makes a one-time bookkeeping change. Whatever the nursing home is deducting as the employee's contribution to the medical plan, they continue to deduct, but just take the employee's portion out pre-tax.

"I will have to make changes in my medical plan"

No. The sponsoring nursing home will not have to make any changes in its existing benefits package. You can keep the same medical coverage that you have now.

"My employees will not understand the plan"

Most people in management at nursing homes are initially concerned that their employees will not understand the concept behind the plan. What they don't realize is that their employees, all of whom are taxpayers, understand concepts quickly whenever they have a chance to lower their taxes.

By utilizing the services of a professional enrollment firm, nursing homes can insure that employees perceive the plan positively.

The Time Has Come

Section 125/Cafeteria Plans are an idea whose time has arrived. The decision to adopt one type of Section 125 plan as opposed to another depends on the philosophy, needs, and employee benefits budget of the sponsoring corporation. Many corporations today are setting up "premium conversion" Section 125/Cafeteria Plans as a stepping stone to more complicated approaches.

Most of the legal issues surrounding these programs have been resolved. The Tax Reform Act of 1986 did nothing to alter their tax advantages; in addition, the Budget Reconciliation Act of 1987 did not follow through on earlier threats to cap Section 125 plan benefits. Whether the approach be a "premium conversion" or a "full-blown" flexible benefit plan, corporations of all sizes are rapidly recognizing the value of cafeteria-style plans.

Example I
Without Section 125 Plan                   With Section 125 Plan
     $250.00      Gross Weekly Salary             $250.00
                  Pay Medical Premium
                  Before Tax                      - 20.00
     $250.00      Taxable Pay                     $230.00
                  Federal & Social Security
     - 56.63      Taxes                           - 52.10
     $193.37      Salary After Tax                $177.90
                  Pay Medical Premium
     - 20.00      After Tax
     $173.37      Spendable Income                $177.90
                  Increase in Take Home Pay
                  Per Week                        $  4.53
                  Per Year                        $235.56

Robert D. Heller and Jay Olin are on the staff of the Alpha Benefits Group, which specializes in Section 125 Plans and is headquartered in Warrington, PA.