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► IRS Explains Cafeteria Plan Forfeitures

Some light was shed on the rules related to cafeteria plan forfeitures when the plan sponsor ceases operations and terminates the plan, in Information Letter 2016-0077, issued earlier this year by the Internal Revenue Service (IRS).

A cafeteria plan is a separate written plan maintained by an employer for employees that meets the specific requirements of and regulations of section 125 of the Internal Revenue Code. It provides participants an opportunity to receive qualified benefits on a pretax basis.

Information Letter 2016-0077 addresses the question of whether unused funds in a cafeteria plan default to the IRS. In a word—no.

The IRS confirmed a two-step process:

•   Look to the written cafeteria plan document and summary plan description (SPD) to see what that documentation says.

•   Look to the rules in the cafeteria plan regulations for how to handle forfeitures for an ongoing plan; those rules allow funds to be:

  • Retained by the employer.
  • Used to defray reasonable plan administrative expenses.
  • Returned to current participants on a reasonable and uniform basis (but not based on claims experience).

The IRS did not comment on the exclusive benefit rule that applies to Employee Retirement Income Security Act (ERISA) benefits because the IRS does not have authority over that law. However, to the extent that the cafeteria plan benefits are also ERISA benefits (for example, medical, dental, vision, and health flexible spending accounts (FSAs)), those benefits would have to be used for the exclusive benefit of participants and beneficiaries or to defray reasonable plan administrative expenses.

In other words, the forfeited funds could not revert back to the employer. Governmental plans and church plans, of course, are not subject to ERISA, but state law restrictions may apply (because there would be no ERISA preemption).



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