By Scott I. Wolf, Esq.
Despite the soft economy, you as a business owner know that valuable employees are hard to replace, and offering your employees benefits in addition to salary is often the best way to keep your employees happy. The new Massachusetts health insurance law requires all employers to maintain a salary reduction plan to allow employees to pay their health insurance premiums on a pre-tax basis. A Cafeteria Plan, or Flexible Spending Account, is merely an add-on to the salary reduction plan that allows employees to have their salary withheld from their paycheck to be used for qualifying expenditures.
The procedure is simple: your Company adopts a plan that allows the employees of the Company to be reimbursed with pre-tax dollars for qualifying out-of-pocket expenses the employees would incur on a regular basis, including, for example, employee-paid insurance premiums, medical and prescription co-payments, medical expenses not covered by insurance, over the counter drugs, day care expenses, dental expenses, Company sponsored life insurance premiums, adoption expenses and transportation costs for parking or public transit.
At the beginning of the Plan year, the employee identifies how much money should be withheld pre-tax from his or her paycheck to be deposited in the Cafeteria Plan, which is merely a ledger entry in the Company's main account. Then, as the employee incurs the expenses, the employee submits receipts or directs the Company to make payments directly to the service provider. This payment service can be provided by third party administrators, who charge a fee and keep the interest that accrues on the holdbacks.
The employees do not pay FICA, Medicare, or state or federal taxes on the redirected salary, which could result in savings of 30% on money they had to spend anyway. It can also make expenses which may not otherwise be deductible to the employee due to IRS rules deductible, and there are certain procedural rules that need to be followed. The deduction amount for the employee's health care premium is unlimited. The deductions for child care are limited to $5,000 per plan year; non-covered health care expenses are unlimited, but we recommend a cap of $3,000-$5,000 to limit the employer's liability, as the employee can use the full amount of the health care allowance before it is actually collected and the Company would have no remedy if the employee quit. The elections cannot be changed during a plan year unless a major change occurs in the employee's life or in the benefits that the Company offers. Money that is not spent in plan year is forfeited to the Company, though the employee has a 2-1/2 month grace period to spend down unused funds.
For you, the Company, the savings can be dramatic, since for every dollar an employee withholds, the Company will save 9.1% since it will not pay the employer's share of FICA (7.65%) and Medicare (1.45%) withholdings. This adds up, particularly where the Employees pay portions of their health insurance and participate in the Cafeteria Plan. For every $10,000 withheld (an easy number to reach with health insurance premiums and day care expenses climbing all the time), the Company (1) saves $910 and (2) can earn interest on the withheld money until the employee requests reimbursement or payment to a vendor.
Highly compensated employees and certain key employees may be subject to limitations on amounts they can contribute to the FSA, but this is by no means overly burdensome and is not a reason to forego implementation. Further, S Corporation shareholders and LLC members may not participate in a Cafeteria Plan.
So, although companies are required by Massachusetts law to have a salary reduction plan to implement the new Mass. healthcare law, you can in turn capitalize on it and provide an ultra-low cost benefit to your employees.
For review of your current plan, or to get the rest of the story, please call Attorneys Scott Wolf or Jenifer Pinkham at 781.848.5028