Cafeteria Health Plans Still Tax Favored

May 21, 2002 ( - Employees can use pretax dollars to pay for cafeteria-style health plan if they're automatically enrolled, and if they can choose between health coverage and cash when hired and annually after that, the Internal Revenue Service said.

The IRS said in a new revenue ruling that the notices on hiring and then annually are aimed at informing workers that pretax salary money will be deducted for indemnity coverage unless the employee elects to take cash to buy the coverage elsewhere. Workers can select family coverage at that time.

IRS officials said employee contributions for an employee-only group health plan with an automatic enrollment provision can be made from pretax funds to the extent that the worker could have selected a cash payment.

In determining an employee’s compensation for tax code Section 415(c)(3) limits (which limit annual contributions to a qualified retirement plan), an employer can choose to treat “deemed Section 125 compensation,” or the excludable amount not available in cash to an employee who cannot prove health coverage elsewhere, as subject to Section 125.

The amount can be treated as “deemed Section 125 compensation” only if the employer does not otherwise inquire about alternate health coverage as part of the enrollment process for the health plan, the IRS said.

A plan will not be deemed nonqualified for using “deemed Section 125 compensation” for the purposes of Section 415(c)(3) for plan years beginning after December 31, 1997 and before January 1, 2002, if the plan is amended to provide the definition of “deemed Section 125 compensation” on or before the end of the 2002 plan year.

Otherwise, such an amendment must be adopted no later than the end of the plan year in which it is effective.

IRS Revenue Ruling 2002-27 appears in Internal Revenue Bulletin 2002-20 dated May 20, 2002.