Rules For Accident and Health Insurance Cafeteria Plans

Time to Review Cafeteria Plan Documents

Cafeteria plans are benefit plans that allow employees to choose certain nontaxable benefits (such as accident or health coverage) in lieu of cash, without the employee having to include the cash in gross income. In effect, such plans enable employees to convert what would otherwise be taxable compensation into excludable benefits suitable to employees' own particular needs.

The Health Insurance Portability and Accountability Act of 1996 (HIPAA) was enacted to improve health insurance availability for individuals who lose health care coverage due to changing or losing their jobs. As a result, some of the rules applying to cafeteria plans needed to be changed to conform the accident and health insurance provisions to the new special enrollment rights provided under HIPAA.

In a cafeteria plan, employees have the right to choose among two or more benefits consisting of cash and qualified benefits. A qualified benefit is any benefit excludable from gross income because of an express provision in the IRC, including employer-provided accident or health insurance, group-term life insurance, elective contributions under a cash or deferred arrangement, dependent care assistance and adoption assistance.

Qualified benefits do not include: long-term care-insurance, medical savings accounts, qualified scholarships, educational assistance programs, and certain other fringe benefits.

An employee may elect to choose between the cash and the qualified benefits before the beginning of the coverage period (generally, the plan year of the cafeteria plan); changes in the election during the plan year usually are allowed only under very limited circumstances.

The IRS recently issued new rules that allow employees to change health coverage (in light of the HIPAA changes) and permit plans to allow changes in coverage during the plan year for a variety of "changes in status." Such changes are limited to specific events, including

  • Changes in marital status —because of marriage, death of a spouse, divorce, legal separation or annulment.

  • Changes in the number of dependents —because of a dependent's birth, adoption, placement for adoption or death or an unmarried dependent's satisfying (or ceasing to satisfy) the requirements for attainment of age or student status.

  • Changes in employment status —because of employment termination or commencement by an employee, spouse or dependent; change in work schedule, including a reduction or increase in the hours of employment by the employee, spouse or dependent; switch between part—and full—time work; strike or lockout; or the beginning or end of an unpaid leave of absence.

  • Changes in residence or worksite by the employee, spouse or dependent .

  • Changes due to judgment, decree or order —resulting from divorce, legal separation, annulment or change in legal custody, including a qualified medical child support order.

  • Changes due to entitlement to Medicare or Medicaid .

  • Significant coverage or cost changes .

  • Changes in status for other qualified benefits .

  • Cessation of required contributions .

  • Special requirements concerning the Family and Medical Leave Act .

Under the new rules, only the limited circumstances specifically listed qualify as changes in status. Other employment situations—such as changing from hourly to salaried employment or from union to nonunion contracts or even introducing new benefits to an existing cafeteria plan in mid-year—do not. Offering revocation or election possibilities for these other situations may endanger a plan's qualification.

To comply with the new rules (and thereby continue to qualify as cafeteria plans), plan documents, administrative procedures and employee communications must provide for the revocation and election of benefits based on these changes in status.

For a discussion of this and other recent developments, see the Tax Clinic, edited by James Connor, in the April 1998 issue of The Tax Adviser .

Nicholas Fiore, editor
The Tax Adviser


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