Many employers offer employees the option to use the employer’s cafeteria plan to opt-out of group health plan coverage and receive taxable cash payments. As open enrollment gears up this fall, it is important for employers sponsoring Internal Revenue Code (“Code”) Section 125 cafeteria plans to consider the possible ramifications such opt-out payments may have on employees and their benefits.
First, taxable cash paid in consideration for opting out is reportable as Form W-2 income to those employees opting out. Employers need to determine whether based on retirement plan terms that income must be considered for purposes of 401(k) or 403(b) plan deferrals and matching contributions, as well as for other benefits purposes (e.g., pension compensation). Alternatively, an employer may want to consider amending its retirement plan to specifically exclude opt-out payments from compensation for purposes of plan benefits. If making such a change, it is important to make sure the retirement plan definition of compensation is nondiscriminatory as related to non-highly compensated employee participants.
When offering an opt-out benefit, employers should consider whether taxable cash received by reason of an opt out must be included when calculating an employee’s regular rate of pay under the Fair Labor Standard Act (“FLSA”). In Flores v City of San Gabriel, the Ninth Circuit Court of Appeals (California, Arizona, Nevada, Oregon, Washington, Idaho, Montana, Alaska and Hawaii) held that cash payments to employees for unused portions of their employee benefits allowance must be included in calculating their regular rate of pay for FLSA purposes. An employer can exclude cash payments made pursuant to a “bona fide” plan under the FLSA, however qualifying plans cannot allow more than “incidental” cash payments and the benefits plan in the Flores case did not qualify.
Employers within the Ninth Circuit that are not factoring in similar types of payments and calculating the pay rate accordingly must address this issue based on Flores. Outside of the Ninth Circuit, employers should work with counsel to analyze their situation in the context of how the law has been interpreted in their Circuit.
