[House Hearing, 115 Congress]
[From the U.S. Government Publishing Office]
CAFETERIA PLANS: A MENU OF NON-OPTIONS FOR SMALL BUSINESS OWNERS
=======================================================================
HEARING
before the
SUBCOMMITTEE ON ECONOMIC GROWTH, TAX, AND CAPITAL ACCESS
OF THE
COMMITTEE ON SMALL BUSINESS
UNITED STATES
HOUSE OF REPRESENTATIVES
ONE HUNDRED FIFTEENTH CONGRESS
FIRST SESSION
__________
HEARING HELD
MARCH 16, 2017
__________
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Small Business Committee Document Number 115-009
Available via the GPO Website: www.fdsys.gov
_________
U.S. GOVERNMENT PUBLISHING OFFICE
24-531 WASHINGTON : 2017
____________________________________________________________________
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HOUSE COMMITTEE ON SMALL BUSINESS
STEVE CHABOT, Ohio, Chairman
STEVE KING, Iowa
BLAINE LUETKEMEYER, Missouri
DAVE BRAT, Virginia
AUMUA AMATA COLEMAN RADEWAGEN, American Samoa
STEVE KNIGHT, California
TRENT KELLY, Mississippi
ROD BLUM, Iowa
JAMES COMER, Kentucky
JENNIFFER GONZALEZ-COLON, Puerto Rico
DON BACON, Nebraska
BRIAN FITZPATRICK, Pennsylvania
ROGER MARSHALL, Kansas
VACANT
NYDIA VELAZQUEZ, New York, Ranking Member
DWIGHT EVANS, Pennsylvania
STEPHANIE MURPHY, Florida
AL LAWSON, JR., Florida
YVETTE CLARK, New York
JUDY CHU, California
ALMA ADAMS, North Carolina
ADRIANO ESPAILLAT, New York
BRAD SCHNEIDER, Illinois
VACANT
Kevin Fitzpatrick, Staff Director
Jan Oliver, Chief Counsel
Adam Minehardt, Minority Staff Director
C O N T E N T S
OPENING STATEMENTS
Page
Hon. Dave Brat................................................... 1
Hon. Dwight Evans................................................ 2
WITNESSES
Ms. Jennifer Brown, Manager of Research, National Institute on
Retirement Security, Washington, DC............................ 3
Ms. Paula Calimafde, Chair, Small Business Council of America,
Bethesda, MD................................................... 5
Ms. Elise Feldman, President, Feldman Benefit Services, Inc.,
Springfield, NJ................................................ 7
Mr. Matt Tassey, Treasurer, National Association of Insurance and
Financial Advisors, Portland, ME............................... 9
APPENDIX
Prepared Statements:
Ms. Jennifer Brown, Manager of Research, National Institute
on Retirement Security, Washington, DC..................... 17
Ms. Paula Calimafde, Chair, Small Business Council of
America, Bethesda, MD...................................... 22
Ms. Elise Feldman, President, Feldman Benefit Services, Inc.,
Springfield, NJ............................................ 28
Mr. Matt Tassey, Treasurer, National Association of Insurance
and Financial Advisors, Portland, ME....................... 31
Questions for the Record:
None.
Answers for the Record:
None.
Additional Material for the Record:
Congresswoman Yvette D. Clarke Statement..................... 36
U.S. Chamber of Commerce..................................... 38
CAFETERIA PLANS: A MENU OF NON-OPTIONS FOR SMALL BUSINESS OWNERS
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THURSDAY, MARCH 16, 2017
House of Representatives,
Committee on Small Business,
Subcommittee on Economic Growth,
Tax, and Capital Access,
Washington, DC.
The Subcommittee met, pursuant to call, at 10:00 a.m., in
Room 2360, Rayburn House Office Building. Hon. Dave Brat
[chairman of the Subcommittee] presiding.
Present: Representatives Brat, Knight, Kelly, Gonzalez-
Colon, Fitzpatrick, Evans, Chu, Murphy, and Clarke.
Chairman BRAT. Good morning, everyone. We have a few
competing committees meeting this morning so you will see
people coming and going as we proceed. And I just want to thank
you all for being with us today. I call this hearing to order.
The Tax Code has many purposes apart from revenue
collection. Cafeteria plans are a prime example. They were
enacted in 1978 to encourage employers to provide benefits for
lower-paid employees. Cafeteria plans have become a popular
form of employee compensation. They are employer-provided
benefit plans under which employees may choose between cash and
benefits. For example, if you participate in a Flexible
Spending Account, commonly called an FSA, or have dental or
vision coverage that you pay for directly from your paycheck,
you are participating in a cafeteria plan. You have the choice
to receive your full paycheck or to forego some portion of it
in exchange for benefits that you choose and, most importantly,
ones you receive pretax.
Cafeteria plans are available across the board to large-
and mid-sized companies, nonprofits, schools, universities, and
the Federal Government. However, one major category of people
who are not allowed to participate in a cafeteria plan is small
business owners. They can sponsor these plans for their
employees, but they cannot personally participate. This
provides a disincentive to offering the plan in the first
place.
Today's hearing will focus on why small business owners are
not treated on par with larger employers. Today's witnesses
will also discuss the effects of this policy on small business
employees and whether this policy should be changed.
I would like to thank our witnesses for coming today. I
look forward to your testimony. I now yield to our Ranking
Member Evans for his opening remarks.
Mr. EVANS. Thank you, Mr. Chairman. I would like to say
good morning also to the panel of witnesses who are here today.
Employers are not required by law to offer benefits such as
health coverage, retirement plans, or paid vacations. These
types of benefits can be quite costly to small businesses. So
why do employers offer them? The answer is simple: to hire and
retain the most talented workers.
Many Americans rely on employer-based benefits, but small
employers often face challenges in offering these benefits to
their hard-working employees; small firms' administrative costs
and complex rules when they contemplate employee benefits. For
these reasons, many business owners often forgo them offers.
A lack of employer-provided benefits can harm the
businesses because it makes hiring and retaining workers
difficult. Without benefits, employees may not work as hard or
stick around to help the businesses prosper. This is
particularly important in competitive fields where employees
have monthly options available to them. The businesses that can
afford to offer benefits, even if small, usually have a wide
pool of candidates available to them. Because of the perceived
higher costs of benefits, small businesses are often reluctant
to even investigate employee benefit plans.
Yet, what many small businesses almost may not realize that
they have options, one of those options is the cafeteria plan
under section 125 of the Internal Revenue Code. These plans can
help employers use the Tax Code to their advantage while others
benefit from their employees. By using pretax money, the
employer saves by not having to pay FICA and unemployment tax.
In many cases, this savings can add up to as much as 20 percent
of every dollar being passed through the plan. Such savings can
be reinvested in the business. However, there are also some
complex rules making them confused to small business owners.
For instance, nondiscriminatory rules exist to ensure fairness
for all employees enrolled in the plan.
I think we can all agree that nondiscriminatory rules serve
as an important purpose in that they protect rank and file
employees, but these rules also have led employers to shy away
from employee benefit plans. To cause further confusion, only
small business owners can enroll in the very plans they offer
their workers. Pass-through business owners are not allowed to
participate in these plans, which create a significant problem
because the majority of small entities are structured in that
way. In fact, between 1980 and 2011, the number of pass-through
business tax returns has increased by 175 percent, roughly 109
million returns to about 30 million returns.
Owners of business structure as pass-through entities are
unduly penalized simply based on their business planning
decisions. This in turn harms the millions of employees working
for them because the rule impacts owners from decisions to
offer the plan. Any policy regarding workers' benefits should
ensure small employers have the resources they need to overcome
challenges and starting and continuing to them. It is not only
in their best interests, but it is in our economy's.
And that is why we are here today. This hearing will allow
members of the Committee to learn more about how--the cafeteria
plans and how they can make it work better for our Nation's
small businesses. I look forward today to the testimony and
thank the witnesses for their participation.
I yield back. Thank you, Mr. Chairman.
Chairman BRAT. Thank you very much.
If Committee members have an opening statement prepared, I
ask they be submitted for the record.
I would like to take a moment to explain the timing lights
for everyone here. You will each have 5 minutes to deliver your
testimony. The light will start out as green. When you have 1
minute remaining, the light will turn yellow. Finally, at the
end of your 5 minutes it will turn red. I ask that you try to
adhere to that time limit if at all possible.
And with that, we will start our introductions. I would
like to start with Jen Brown. Our first witness this morning is
Ms. Jennifer Brown, manager of research at National Institute
on Retirement Security, NIRS, in Washington, D.C. In this
position, she conducts original research and analysis regarding
issues related to retirement. She is also an adjunct professor
at American University, where I did my Ph.D. in economics. So
welcome, fellow Eagle. And a fellow with American's Tax Policy
Center. She is a contributor to the fifth edition of the ERISA
litigation treaties and is widely published and quoted. She
holds an LL.M. in taxation and a certificate in employee
benefits law from Georgetown. She earned both her J.D. and her
master's degree in law and society from American.
Ms. Brown, you have 5 minutes, and you may begin. Thank you
very much.
STATEMENTS OF JENNIFER BROWN, MANAGER OF RESEARCH NATIONAL
INSTITUTE ON RETIREMENT SECURITY; PAULA CALIMAFDE, CHAIR, SMALL
BUSINESS COUNCIL OF AMERICA; ELISE FELDMAN, PRESIDENT, FELDMAN
BENEFIT SERVICES, INC.; MATT TASSEY, TREASURER, NATIONAL
ASSOCIATION OF INSURANCE AND FINANCIAL ADVISORS
STATEMENT OF JENNIFER BROWN
Ms. BROWN. Thank you, Chairman.
Thank you all for the invitation to join you today to
discuss revisions to section 125 of the Internal Revenue Code
as it relates to small business owners. Again, my name is
Jennifer Brown, and I am the manager of research at the
National Institute on Retirement Security, often called NIRS.
In addition, I am also a tax policy fellow at American
University's Kogod School of Business.
Section 125 of the International Revenue Code regulates
``cafeteria plans,'' which are tax-favored methods for offering
a variety of fringe benefits to employees on a pretax basis.
They are called cafeteria plans because these plans give
employees the ability to select benefits from a menu set by
their employer in exchange for forgoing compensation.
The most popular fringe benefits that can be offered
through such plans are accident and health benefits, adoption
assistance benefits, dependent care assistance, flexible
spending arrangements, and health savings accounts.
Similar to other types of employee benefit plans, cafeteria
plans must meet separate nondiscrimination requirements, which
were created in order to prevent benefits that are exclusively
offered to ``highly compensated'' officers, shareholders, or
spouses or dependents of an officer or a shareholder. But
section 125 contains an additional nondiscrimination rule which
limits nontaxable benefits offered to ``key employees'' or
officers and owners of a company to 25 percent of all benefits
offered in a plan.
Self-employed individuals, partners in a partnership, and 2
percent shareholders of an S corp are excluded from
participating in section 125 cafeteria plans, but these
individuals are still able to sponsor plans for their
employees. This is unlike pension, profit-sharing, and stock
bonus plans where section 401(c) of the code allows that self-
employed individuals can participate in these plans alongside
their employees.
I will now spend the remainder of my testimony focusing on
the legislative history of section 125.
Provisions excluding highly compensated individuals from
tax-sheltered retirement plans have been in place since the
1942 Revenue Act, after employers sought to provide tax-
sheltered retirement benefits to officers, shareholders, and
highly compensated employees.
Because the Tax Code did not prohibit the payment of
employee health insurance premiums prior to 1978, many
corporations adopted plans that reimburse the medical expenses
of shareholders and officers, but not those of rank-and-file
employees. The Treasury Department became very concerned about
these ``particularly abusive situations,'' and singled out four
closely held corporations which reimbursed the medical expenses
of shareholder officers as a way to disguise otherwise taxable
dividends.
Treasury's fears in 1978 have manifested themselves in
three ways that impact small businesses. First, Congress and
the Revenue Act of 1978 legislated the creation of cafeteria
plans with the nondiscrimination provision that prohibits such
plans that do not discriminate in favor of highly compensated
participants.
Second, Congress, as part of the Tax Reform Act of 1984,
addressed some of Treasury's concerns regarding cafeteria plan
nondiscrimination issues by prohibiting plans that favored the
highest paid officers and owners, termed ``key employees,'' by
prohibiting that they receive more than 25 percent of the total
benefits provided by the plan. This provision
disproportionately affects the ability of small employers and
firms to offer cafeteria plans. In a large firm, a key employee
could still be offered significant benefits through a cafeteria
plan without exceeding the 25 percent threshold. On the other
hand, in a small firm or organization, even limited benefits
provided to a key employee could quickly exceed the 25 percent
threshold.
Finally, in 2007, the IRS proposed regulations that
prohibited sole proprietors, partners, 2 percent shareholders
of an S corp, and directors of corporations from participating
in cafeteria plans alongside their employees, but still allowed
for these individuals to sponsor a plan.
In conclusion, Treasury's concerns about the abuse of
cafeteria plans by owners and officers of closely held
corporations have greatly impacted small businesses and their
ability to sponsor these plans. Even though Congress in 2010
eliminated the strict nondiscrimination requirements for
cafeteria plans sponsored by small employers with under 100
employees by creating ``simple cafeteria plans,'' today, small
employers, including self-employed individuals, partners in a
partnership, and 2 percent shareholders of an S corp may only
sponsor cafeteria plans, but cannot participate in these plans
alongside their employees. Thank you.
Chairman BRAT. Thank you, Ms. Brown. We appreciate your
testimony. I see you put all those degrees to good work. Thank
you.
Our next witness is Ms. Calimafde. Did I get that right?
All right.
Ms. CALIMAFDE. Wait. I will put on my sign. You did.
Chairman BRAT. Ms. Calimafde is a principal at Paley
Rothman, a small-business law firm in Bethesda, Maryland, where
she chairs the retirement plans, employee benefits, and
government relations practice group. She also chairs the Small
Business Council of America, which represents the interests of
privately held and family-owned businesses on Federal tax,
healthcare, and employee benefits matters. She is widely
published and has received numerous awards. She is barred in
both Maryland and D.C., and received her law degree from
Catholic University.
Ms. Calimafde, thank you for being here today, and you may
begin your testimony. Thank you.
STATEMENT OF PAULA CALIMAFDE
Ms. CALIMAFDE. Thank you. And I thank all of you for having
these hearings. It is a very important subject for small
business. It may not sound too sexy, but it is really critical,
and hopefully I will be able to prove to you why in the next
few minutes.
I am also testifying on behalf of, in addition to the Small
Business Council of America, the Small Business Legislative
Council, which is a 40-year-old trade association comprised
exclusively of trade associations which represent small
business interests. And the SBLC covers interests of small
business in all areas of our economy, including manufacturing,
retailing, distribution, professional and technical services,
construction, transportation, and agriculture. So it covers the
whole thing.
I am also a long-time member of the Employee Benefits
Committee of the U.S. Chamber of Commerce, and I am not
representing them today, but it is important that I have been
with that committee for more than 20 years.
There are three points I would like to get across today. If
I get nothing else, this is what I would like to get across.
The first is that cafeteria plans provide extremely valuable
benefits for small businesses and for all employees. And I will
go into the benefits and why they are so important.
The second point I would like to get across is that every
employee in the country, except for owner-employees of pass-
through entities, is eligible to be in a cafeteria plan. So it
is really discriminatory against all of these small business
owners who are out there working every day, but because they
chose to operate in a pass-through entity they are not
eligible. And I will explain in real life what that translates
to is most small businesses do not sponsor full-fledged
cafeteria plans for their employees. So not only is that
provision harming the owner-employees of small businesses, it
is also harming their employees themselves.
And third, I want to get across the idea that if HSAs, or
health savings accounts, are an important feature in the new
healthcare law that may be working its way through Congress,
the best way to promote HSAs is through cafeteria plans. And I
will explain why cafeteria plans make it easier for employees
to select benefits in a moment.
So as mentioned by Jen, the cafeteria plans provide an
enormous scope of benefits or can provide an enormous scope of
benefits to employees, and it includes everything from paying
for braces and eyeglasses to getting more dental or vision
insurance, picking up supplemental health insurance plans that
provide for such things as additional payments if you get
cancer or you are hospitalized or accidents. It picks up, or it
can pick up, disability income plans, both long and short
disability income plans, group term life insurance,
contributions to HSAs, contributions to 401(k)s. So picture, if
you would, a large spectrum of benefits that these plans offer
and the employees are allowed to pick which benefits are most
important to them.
As I mentioned before, small businesses do not offer these
plans widely, and even though you all passed legislation in
2010 known as the SIMPLE Cafeteria Plan, which helped the
situation dramatically because before the SIMPLE, the types of
discrimination laws in place basically made these unworkable
for small businesses. They worked very well for large
businesses, even mid-size, but they did not work well in the
small business context. But the fact that owner-employees
cannot participate, still, it is very difficult for an owner-
employee to say, well, I am going to offer this large selection
of benefits for my employees. It is going to cost a lot to
offer these benefits. There are administrative costs and I
cannot even participate. So that is a big problem, these plans.
I think one of the most important benefits of a cafeteria
plan that is overlooked is that the employee--the benefits have
been preselected for the employees by the employer. So you have
a choice of a medical plan. You have a choice of a vision plan.
You have a choice of a dental plan. You have a choice of long-
term care. You have a choice of an HSA. It does not require the
employee to go out and find these plans and determine which
plans are best for that employee, and contributions going into
the plan are pre-tax and are taken out of the employer's
payroll. So the same reason why 401(k) contributions--and this
is like a hard number to get your arms around, but believe it
or not, it is 20 times more likely that an employee will make
contributions to a 401(k) plan than they would to their own
IRA. And part of that is they do not want to go and establish
an IRA, but the second part is it is much harder to get your
paycheck, take your money, and then bring it over to the IRA
than having money taken out of your paycheck ahead of time. And
you never see it and it just goes right into the plan and
everything is fine because you were not counting on that money.
You were not living on it.
So the same concepts apply in a cafeteria plan. It can be
payroll deduction, so it does not hurt to save for the medical
insurance or the dental vision or HSA contributions. It is done
for you.
So, and one last comment I would like to make is that in
addition to--if you asked me what is the single most important
change you could do, it would be to allow owner-employees of
pass-throughs to participate in the plans. I think that would
promote the entire cafeteria plan system for small business.
Second would be to increase the limits on dependent care, which
is $5,000 and has been for the last 35 years. So that would be
my thoughts on how you could improve this. And thank you very
much.
Chairman BRAT. Thank you very much.
And our third witness this morning is Ms. Elise Feldman, a
certified pension consultant and accredited investment
fiduciary who founded her own small firm, Feldman Benefit
Services, Inc., in 1983, in Springfield, New Jersey. Ms.
Feldman is a frequent speaker on the topics of retirement
planning, employee benefit programs, entrepreneurship, and
leadership. She is on the board of the Small Business Council
of America, and is a member of the American Society of Pension
Professionals and Actuaries.
Ms. Feldman, you have 5 minutes.
STATEMENT OF ELISE FELDMAN
Ms. FELDMAN. Thank you very much.
I am the president of Feldman Benefit Services, Inc., which
is an actuarial firm, and Outsource, Inc., which is a human
resources consulting firm. I am most pleased to be sharing my
testimony with the Committee, and thank you for inviting me to
do so.
Our firm is a full-service actuarial and employee benefits
company, which clients are small- to mid-sized businesses,
ranging in size from 1- to 3,000 employees. The majority are
closely owned, generally 1 to 10 owners and under 100
employees, unless it is a professional service company firm,
like a law firm or an accounting firm, where there would be
many more partners. We are considered a small business, my own
company.
The Section 125 Plan services that we provide cover annual
testing--eligibility, key employee and concentration tests--
annual compliance letters, and for those with flexible spending
accounts, we provide reimbursement handling. With over 100
employees, we prepare the 5,500 annual reporting forms. Through
providing these services, I have seen firsthand how the
existing laws and regulations that apply to cafeteria plans
impact the decisions that small business owners make with
respect to the benefits they offer. So from our perspective,
you are hearing from me as an actual plan administrator who
does the annual compliance work so that our clients can have
these plans. We do cafeteria plans, qualified plans,
nonqualified, deferred compensation plans as well.
As a result of the current laws and regulations, owner-
employees cannot participate in a Section 125 Plan that they
sponsor for their own employees as you have heard, unless they
are a C corporation. Very few small businesses today are
organized that way. Rather, they tend to be Subchapter S, LLCs,
and LLPs. Our small business clients tend to have a
``paternalistic'' attitude towards their employees and want to
protect them and, as a result, want to offer benefits to them.
In addition to other benefits they may provide, the most
prevalent is health insurance and considered the most valuable
for the employees, and do so through a premium-sharing
arrangement, with the employer paying part of the premium and
the employee paying the rest. However, if a business does not
sponsor a Section 125 Plan, the employees will only be able to
pay for their portion of the premium with after-tax dollars.
Thus, it makes good financial sense to encourage the small
businesses to sponsor a Section 125 Plan, which can allow,
among other things, the premium payment being on a pre-tax
basis.
In addition to health insurance payments, these employers
that sponsor a Section 125 Plan can make a number of other
benefits available, such as medical reimbursement and dependent
care. These give an employee an opportunity to provide better
health care for themselves and their families as the 125 plan
structure enables them to do so more easily and more affordably
because they are pre-tax. The option to take advantage of these
benefits is generally appreciated by the employees. I know, I
give employee meetings.
However, while sponsoring a Section 125 plan can be good
for employees, under current law small business owners who
incur the expense and administrative burden of setting up these
plans must do so with the understanding that they will not be
able to participate in the plan themselves. For those owner-
employees, their ability to utilize the benefits, most
importantly the medical reimbursement and dependent care
provisions, is solely because of their small size and form of
entity. Had these individuals been employees and not owners, or
had been C corporations, this would not be the case.
I would like to give you an example. On Monday, I had a
meeting with an attorney in my office building, and I mentioned
that I was coming here today, and he promptly said my wife has
been upset with me because I keep telling her that I am not
allowed to be in one of these plans and she has not believed
me. And so I ran downstairs and said what would it be if we did
the testing on our plan, and my actuary and I, who are owners,
would be allowed to participate? And we found we failed the
test by a small margin, but, nonetheless, we failed. And that
could be corrected by reducing the amount that my actuary and I
put into the plan, but we never tested it before because I knew
we could not be in it. Alternatively, if we were allowed to
participate, we could decide to change to a SIMPLE, but in
exchange it would be overly complex and unfair testing that are
imposed by the cafeteria plan that makes it so difficult to be
in them.
Because the law firm upstairs has more owners and fewer
employees by ratio, the testing would be even harsher for them
and they would not pass. With three owners and two employees
they would not be able to even sustain the benefits that we can
in my own firm.
Each year, as we offer Section 125 services for our
clients, we get the same routine questions from both employers
and employees. The owner-employee asks when will I be able to
participate, as well as when will we be able to offer over-the-
counter medications again?
As the medical and pharmaceutical industries have now
adjusted so that medications which were previously only
available by prescription can now be obtained over the counter,
the financial dynamics have changed. Eye drops, allergy,
stomach medications, to name only a few, must be paid for with
after-tax dollars. Restoring the pre-tax benefit for over-the-
counter medications would enable employees to better afford
their medications. Employees who feel better, work better, are
healthier, and are more productive.
Lastly, employees ask if there will be any significant
increases to both the annual reimbursement and dependent care
limits. Healthcare costs continue to rise, and there are more
dual-income families now in the workforce. Providing the cost
of child care continues to increase, and yet the limits have
not gone up since the mid-'80s. Increasing the amount the
employees can contribute to their Section 125 plans for these
purposes will help employees cover these necessary costs.
And I welcome your questions.
Mr. KNIGHT. [Presiding] Thank you very much.
I would like to now yield to the Ranking Member, Mr. Evans,
to introduce Mr. Tassey.
Mr. EVANS. Thank you, Mr. Chairman.
It is my pleasure to introduce Mr. Matt Tassey. Mr. Tassey
is the principal at Scribner Insurance, and Burwell & Burwell,
an employee-based broker in Portland, Maine. He also serves as
the treasurer of the National Association of Insurance and
Financial Advisors. He is testifying today on behalf of that
group, one of the Nation's oldest and largest associations
representing the interests of insurance professionals. Welcome,
Mr. Tassey.
STATEMENT OF MATT TASSEY
Mr. TASSEY. Thank you, Mr. Evans.
Good morning. I am Matt Tassey, testifying today on behalf
of the National Association of Insurance and Financial
Advisors. I want to thank you for the opportunity to be here
and share our perspective on cafeteria plans.
As Mr. Evans mentioned, NAIFA is one of the oldest and
largest associations representing the interests of insurance
professionals from every congressional district in the Nation.
Like myself, most NAIFA members routinely talk to their clients
about cafeteria plans and the benefits that they offer.
There are two elements of the cafeteria plan rules that
could be improved in our view. NAIFA strongly encourages
Congress to permit owners of pass-through businesses to
participate--to allow the inclusion of those pass-through
shareholders as well as adding the ability to provide qualified
long-term care insurance in a cafeteria plan.
Since their introduction, cafeteria plans have become a
popular method for employers to provide employee-tailored
benefits. Not every employee has the same needs. A family with
young children has very different needs than a single employee.
Some workers get their health insurance through their spouse's
plan, making employer-provided benefits less attractive.
Many workers value the flexibility of the Flexible Spending
Account arrangement in meeting their projected expenses that
are not covered by insurance, while others would prefer not to
participate and take increased taxable compensation. Cafeteria
plans allow different workers to accommodate their unique
situations in choosing benefits that are most valuable to them.
The advantages of establishing a cafeteria plan for both
employers and employees significantly outweigh any perceived
disadvantages.
While not all pass-through businesses are small, most are.
Business owners ultimately pay the bills for the salaries and
the employee benefits of their organization. It is unfair that
they cannot participate in the cafeteria plan. Owners have
unique benefit needs just like their employees. The Section 125
discrimination rules prevent pass-through owners from designing
a plan that would primarily benefit them. The rules require at
least 75 percent of the plan benefits accrue to the non-highly
compensated participants in the organization.
One of our clients, the Lincolnville Telephone Company is a
family-owned company that serves phone and Internet coverage in
Mid Coast Maine. They have around 40 employees, but 5 of those
employees are family members who are excluded from
participating. They provide a plan anyway to provide the
benefit to their employees and their families and to help
reduce the benefit costs for those employees and their
dependents. They also use the Flexible Spending Account
opportunity to reduce out-of-pocket costs for those employees.
The inability of small business owners to participate in a
plan acts as a disincentive to design, implement, administer,
and pay for the cafeteria plan. Allowing owners to participate
would likely encourage more of them to make plans available to
their workers. That in turn would increase the financial
security of their employees and themselves. For example, we
insure around 60 small employer groups. In my State, Maine,
which happens to be the oldest State in the United States, it
is routinely $1,800 to $2,400 a month for a family coverage for
medical insurance. Their employees could enjoy that benefit,
but they do not, so in the small employer market they choose
not to create the plan and make it available.
The need for long-term care insurance is acute and growing.
The ability to offer long-term care through the convenience of
a cafeteria plan would likely increase the number of people who
could protect themselves against the risk of expensive long-
term care and nursing home costs. It may also ease some of the
pressure on Medicaid and family resources for the loved ones
who do incur long-term care expenses.
In summary, cafeteria plans allow employers to offer
flexible benefits to their workers at a reasonable cost to both
the workers and the employer. It is unfair to exclude pass-
through business owners from eligibility and it may discourage
them from offering and paying for cafeteria benefits to their
employees. Long-term care is much like health insurance. It is
a security product that should be permitted in a cafeteria
plan.
Thank you for the opportunity to be here. I would be
pleased to answer any questions that you may have.
Mr. KNIGHT. Thank you very much.
And we will go to panel discussion. We can take up to 5
minutes from up here, and we will try and be as direct as we
possibly can in our questions.
I will go to Ms. Brown. You mentioned that fear was driving
a force behind Treasury actions in this area through 2007.
While there were certainly abuses early on, is there any more
current evidence that those fears are still justified given the
strong anti-discrimination provisions that have been added
since 1978?
Ms. BROWN. Thank you for your question. It is not clear
within the 2007 regulations, or any regulations proposed since
1978, that there were actual palpable concerns, though I will
tell you that the IRS would probably remind everyone that there
are additional protections in each section of the code below
125, meaning that any of these benefits that are offered have
their own particular code section and additional protections
under those code sections.
Mr. KNIGHT. Okay. And we will follow up a little bit on
that. You noted that in 2010, the Affordable Care Act relaxed
the nondiscrimination requirements for small employers with
fewer than 100 employees and provided a safe harbor for SIMPLE
cafeteria plans. How does this safe harbor work?
Ms. BROWN. All right. So specifically, if a small employer
has less than 100 employees, they are not required to perform
nondiscrimination tests on the plan for group life insurance,
medical reimbursement, dependent care assistant programs, as
long as they continued the plan without interruption, offer the
plan to all eligible employees, and provided a minimum
contribution for each employee that is not a key employee.
Mr. KNIGHT. Okay. Let's see. We will go to Ms. Feldman.
There are a couple things on your testimony but we will start
with this. You mentioned that absent a Section 125 Plan, an
employee would not be able to pay his or her portion of health
insurance premiums with after-tax dollars.
Ms. FELDMAN. Pretax dollars.
Mr. KNIGHT. With pretax dollars, correct. Is there a
mechanism? Is there really no mechanism here? Or is there a
mechanism by which this can be accomplished, that people can go
into this system as you said, people will be more apt to put
money into a 401(k) if it is being taken out of their paycheck
than if they were of taking their own check and writing it into
an IRA? Can you talk about this mechanism, how this will work
better?
Ms. FELDMAN. Well, there are two main requirements for an
employee to be able to pay for premiums pretax. One is that
there has to be a plan document which says so under Section
125, and the second is that the employee has to elect to have
that happen. It cannot be done automatically. So if a small
employer has their own plan, they have the administrative cost
of establishing the plan and then they just bill it through
their payroll system. If they are a PEO, they go through a
provider. Hopefully, there is a document there, and I have to
tell you probably 60 percent of the time there is not one.
Mr. KNIGHT. And I know from my own experience, when I was a
financial advisor, it was hard to go into companies and say
that this is the best benefit for you to sign up for your
401(k). And they would all ask about an IRA or something that
they could do. I would say, you know, your number one thing
that you can do is sign up for, your 401(k) in your business.
It is taken out so that typically takes away from your kind of
decision-making. You understand where your money is going every
month, because it is already taken out, and that is kind of the
best plan for you to get moving in your financial success or
your independence when you retire. Sometimes that is hard for
people to understand, and sometimes that is hard for people to
sign up right there, especially young people that do not
understand that they are going to be 50 or 60 or 65 one day. So
it is very hard to get a 22-year-old to do that, but okay.
I am going to move on to the ranking member for his
questions.
Mr. EVANS. Thank you, Mr. Chairman.
Ms. Feldman, I want to kind of follow up a little bit.
There are quite a few Federal and State laws that define the
employer and the employee relationship. This is particularly
important for employee's spouse working for the company, who is
also taking advantage of the cafeteria plan. In this instance,
what are tax implications for the owner and the employee's
spouse, and does this situation always impact on employers'
decisions to offer cafeteria plans to the employees?
Ms. FELDMAN. In a small business where there are two-income
families, it is very possible that each spouse works somewhere
and has a plan. And that is also very difficult to test because
we can double up on the rules. And if an employee's spouse is
in a plan and they have an HAS, then the employee in the
company with the cafeteria plan can double up on the rules. So
we are now responsible for administering, trying to determine
what an employee has outside of the place where they work. It
makes it a little difficult to administer.
Mr. EVANS. Mr. Tassey, the goal of this Committee is to
assist small businesses in providing benefit plans to the
employees, but because of perceived costs, many small firms do
not. Can you explain how modifying certain aspects of the
cafeteria plan can help us accomplish that goal?
Mr. TASSEY. The way to accomplish that goal is to let the
employer who is really ultimately responsible for paying the
costs of running his organization to participate in the plan.
It is voluntary, so if he does not see at least a positive
effect for the employees at least and be benevolent and offer
it even though they cannot participate, but it would be even
more encouraging if he could participate. You will often find
that in small businesses, and we deal with dozens of them
because that is what Maine is, it is mostly small businesses,
often there is a son in the business or there is a nephew in
the business or a cousin, and they are not allowed to
participate either because they are a family member. So
allowing the pass-through owners and their families to
participate would be the easy way. The document itself is very,
very tried and true and is available in any number of
providers. It is the follow-through and the testing that
happens, but if you let the owner have some of the benefits
that he is providing to his employee, I think that would go a
long way.
I mentioned as part of my testimony, one of the most
difficult things facing Americans that we do not talk about is
long-term care, and it is crushing our State. And being able to
offer long-term care within that portfolio would be a big gain
for most people. I hope that is responsive.
Mr. EVANS. Ms. Brown, the self-employed owner of specific
types of pass-through entities are ineligible from
participating in their own cafeteria plans. Are you aware of
any abuses by small business owners or their plan sponsors that
necessitate this rule?
Ms. BROWN. I am not aware of any, nor is there any in the
legislative history of this provision of the code. So the only
mention is, again, back from Treasury's initial identification
of four closely held corporations in 1978.
Mr. EVANS. Thank you, Mr. Chairman. I yield back the
balance of my time.
Mr. KNIGHT. Thank you very much. And we will go to Mr.
Fitzpatrick for his questions.
Mr. FITZPATRICK. Thank you, Mr. Chairman, and thank you all
for coming in today.
My question is for the whole panel, and it is going to just
be a broader question. If you could just identify the top three
hurdles that are preventing small businesses from having access
to cafeteria plans and what this Committee can do, what
Congress can do from the legislative side, how much of this is
an administrative issue for the executive branch of government?
Mr. TASSEY. There are millions of small businesses, and
when you talk about small businesses, the Federal Government, I
think, defines that as under 1,000 employees. In our world it
is under 25 employees or 20 employees, and cash flow is their
first problem. Once they get over that and they have an
established business, then they have to look at the costs.
The only thing in America that continues to go without any
hope of solving are college tuitions and health care. And what
is happening is as health care continues to escalate and people
expect to be covered when they have health care, they may not
know what they have, but they expect it to be covered, we have
got to get a handle on that. And that is going to be difficult.
But the easy way to at least move forward would be to allow
that owner who may have three or four employees to be able to
take care of his healthcare costs pretax. It is a burden. If
you have a family business and they are going to net $80,000 or
$100,000 after salary and I am going to charge them $2,500 a
month for their medical insurance, that is the burden. So to
make it pretax would be a huge improvement for people. Thank
you.
Ms. FELDMAN. I can hone in on three right off the top. One
is to allow owner-employees pass-through entities to
participate. Two is to increase the limits because the cost of
coverage and the cost of expenses is well beyond the time
period of when we established these plans, and to overcome the
concern and fear about discrimination because even if owner-
employees participate in the plan, they are not faking
benefits, they are not faking expenses. And if they have a bill
from a doctor, it is real. It is not that they are going to ask
for money that is going to reimburse, one, they have not laid
out, and two, that is not an exact form to pay the bills that
they have.
Ms. CALIMAFDE. My top three are similar but not identical.
One is, I think, clearly allowing small business owners to
participate in the cafeteria plan. When we talk about small
business owners, these are people who are actually working.
They are owner-employees, so they are the only employees in the
country who are not allowed to participate; really
discriminatory. And from a practical viewpoint, it is difficult
to convince an owner-employee of a pass-through to sponsor a
full-blown cafeteria plan which offers a lot of these benefits
when they know that he or she cannot participate.
So it is just human nature. It is a cost-benefit analysis
and it is like thank you, I am not interested since I do not
want to incur all this extra burden and administrative expense
and I cannot even be involved.
The second would be, and I mentioned this earlier, the
$2,500 limit, which I think is $2,600 today, was put in by the
Affordable Care Act and, in a sense, is a revenue-raiser to pay
for the Affordable Care Act. And that limit was never in place
before, and at a minimum that should be $5,000. And the $5,000
for dependent care, as I mentioned, has been in place for 35
years. And 35 years ago, I am sure that was enough to get
childcare and elder care. Today it is not.
And the third thing is I agree with Mr. Tassey, I think
long-term care should become a qualified benefit under the
cafeteria plan. I think it was not simply because it was not
around when 125 came into place, and I think it is a very
valuable benefit, and I think as our population ages, we have
to do something to help. And in a cafeteria plan, the employees
help themselves in effect.
Ms. BROWN. So I have similar suggestions. I would first
suggest that the requirements for these plans are applied
evenly, meaning they match 401(c) for pension profit-sharing
plans. Treasury and the IRS have relaxed those rules for small
business owners and entrepreneurs, and so it would make sense
that they would be relaxed in this context as well.
Secondly, I agree with Mr. Tassey, long-term care benefits
are essential. They should very much be offered in these plans.
I do not understand why they were not offered or excluded.
And then last, I really believe that--and this is something
that you could ask for--finalized regulations out of the IRS on
this issue or new regulations out of the IRS would be a
wonderful thing here. Currently, we are all working under 2007
proposed regulations. You know, we really should have some
finalized regs. I have spoken with the IRS on this issue and
they do want to look at this again and would welcome
suggestions on it. But these regs are old and cold.
Mr. FITZPATRICK. Mr. Chairman, I yield back.
Chairman BRAT. [Presiding] Thank you all very much. I think
I will continue with a couple questions that go a little
further than what you were just getting at. Does the change in
administration have any impact on what you were just getting at
in terms of regs or putting it into law? And all of you are
free to weigh in on that one.
Ms. BROWN. I can weigh in. I mean, I did speak to the IRS
on Monday about this issue, and the reason they gave me, which
makes sense to me--I suggested a reason to them and they echoed
it back to me, there was a change in administration after 2007.
They then proposed the healthcare law. IRS has been very busy
since 2010 in articulating these regulations. Depending on what
happens and what priority this is given depends on whether or
not this will be reproposed, but, at the same time, they are
aware that this is out there. They understand that they need to
look at this again. So there is some wiggle room here.
Chairman BRAT. That is great. And I want to open this up
just to see. When I go back home I hear from small business
people on this issue, And then I also hear that the same kind
of limitation applies to health insurance purchases for
employees under some of the mandates from the past, but the
owner could not give themselves the same health care pretax
advantage, not just cafeteria plans, but health insurance in
general. Is that the case out there? Can you comment on that?
Mr. Tassey, if you want to start off, or anybody who wants
to weigh in.
Mr. TASSEY. It is nondeductible, so it is his personal
expense.
Chairman BRAT. Right.
Mr. TASSEY. Now, if he became a C corporation it is a
deductible expense directly, but everybody went to a pass-
through. And once you are in a pass-through, it costs you money
to get out of it. So that is why. It is just a nondeductible
item.
Chairman BRAT. And is that analogous to the issue we are
talking here?
Mr. TASSEY. It is.
Chairman BRAT. I mean, is it the same issue?
Mr. TASSEY. It is a first cousin.
Chairman BRAT. Okay, good.
Mr. TASSEY. If we allow you to do pretax for pass-through
entity----
Chairman BRAT. Right.
Mr. TASSEY.--shareholders, it solves the problem.
Chairman BRAT. Good. And should we bundle these together
since we are going to go through some heavy lifting in the
first place? I mean, do they fit? Are they first cousins of
that order that they fit in the same regs and the same bill? Or
should we just treat them separately?
Mr. TASSEY. I think it should be together. I am not a tax
attorney. I would have to think about that.
Chairman BRAT. Anybody else want to weigh in what they
experienced?
Ms. CALIMAFDE. Well, as a tax attorney I am willing to
weigh in. They certainly could go together.
Chairman BRAT. Okay.
Ms. CALIMAFDE. And also, I am going to try to say this as
diplomatically as possible--I may not be known for my diplomacy
skills--but I do think there should be a difference in the way
small businesses are approached in a new administration. I
think for years and years, small business owners, particularly
of pass-throughs, are just seen as like abusers of the tax
system by some folks in Treasury and IRS; not all of them, but
a number of them. And I think a great deal of time is spent
sitting around, trying to figure out, gee, well, what if an
owner did this? And what if an owner did that? And you end up
with regulations that are thousands of pages long because they
are sitting around what if-ing instead of giving us bright-line
tests that we can follow because the vast majority of small
business owners that I have ever worked with are trying to stay
well within the law. They have no interest in being a name on a
Supreme Court case, I can assure you.
But what they want is bright-line tests. And the grayer
they make the rules, it is harder for us to follow them. So I
personally get very upset with this sense that you run into at
IRS that small business owners are up to no good and they need
regulations and regulations and regulations. Did I say that
diplomatically?
Chairman BRAT. That was very diplomatic. And that is the
feedback I hear back home, too. It is staggering the amount of
paperwork and check work they are having to do just to comply.
Does anybody else want to weigh in? I have got a minute
left.
Ms. FELDMAN. These are similar situations in qualified
plans for the ADP and ACP tests for 401(k) plans and through
the benefit limits that also affect small businesses and
business owners that would not occur in a large business.
Chairman BRAT. Any concluding remarks in 43 seconds?
Ms. CALIMAFDE. I have one. I would like to thank you guys
for your time and your attention to this matter. It really is
important to small business owners, and as I mentioned earlier,
it is not only going to be important to the owners; it is going
to be important to their employees as well because then they
will be able to get these plans. So thank you for your time and
attention.
Chairman BRAT. Super. Same to all of you. Thank you very
much today. And Mr. Evans, pretty much you are all set? All
right. Good.
I would like to thank, obviously, all of our witnesses
today for an outstanding job and for participating with us
today. It has been a very good discussion. You have all raised
important points and provided some real pathways for moving
forward.
As we move forward on historic tax reform, it is critical
that small business issues are not lost in the shuffle. This is
an area that requires attention and can easily be fixed. I
commend the witnesses for not only raising the issues, but for
recommending real world solutions. It is important that we have
established a record here today upon which to build tax reform
for small businesses.
I ask unanimous consent that members have 5 legislative
days to submit statements and supporting materials for the
record.
Without objection, so ordered.
This hearing is now adjourned. Thank you all very much.
[Whereupon, at 10:50 a.m., the Subcommittee was adjourned.]
A P P E N D I X
U.S. House of Representatives
Committee on Small Business
March 16, 2017
Testimony of Jen Brown
Manager of Research, National Institute on Retirement Security
(NIRS)
Tax Policy Fellow, American University Kogod School of Business
Thank you for the invitation to join you to discuss
revisions to Sec. 125 of the Internal Revenue Code as it
relates to small business owners. My name is Jen Brown and I am
the Manager of Research at the National Institute on Retirement
Security (NIRS). NIRS is a non-profit research and education
organization which was established to inform policymaking by
demonstrating the importance of retirement security to
employers, employees, and American economic performance. In
addition, I am also a Tax Policy Fellow at the American
University's Kogod School of Business, where I conduct non-
partisan research on tax and compliance issues specific to
small businesses and entrepreneurs. Prior to my appointment at
Kogod and at NIRS, I was an Employee Benefits Law Specialist
for the U.S. Department of Labor's Employee Benefits Security
Administration, where I worked on retirement, welfare, and
health plans. In addition to my federal government service, I
was also an ERISA Legislative History Research Assistant at the
Georgetown University Law Center.
Overview of Sec. 125 ``Cafeteria'' Plans
Section 125 of the Internal Revenue Code (``Code'')
regulates ``Cafeteria Plans,'' which are tax-favored methods
for offering a variety of fringe benefits to employees on a
pre-tax basis through a plan offered by an employer. They are
called cafeteria plans because these plans given an employees
the ability to select benefits from a menu set by their
employer, in exchange for forgoing compensation. Some cafeteria
plans offer a choice between cash and one or more type of
insurance coverage, while other plans offer one or more
reimbursement accounts.\1\ The fringe benefits than can be
offered through such plans are:
---------------------------------------------------------------------------
\1\ David Ralsh, Cafeteria Plans, 397 Tax Mgmt. Port. (BNA) B-4
(2017).
1) Accidental death and dismemberment insurance
---------------------------------------------------------------------------
policy (Sec. 106);
2) Accident and health benefits (Sec. Sec. 105-106);
3) Adoption assistance benefits (Sec. 137);
4) COBRA continuation coverage; (Sec. 106);
5) Death and dismemberment insurance;
6) Dependent care assistance (Sec. 129);
7) Flexible Spending Arrangements (FSAs);
8) Group term life insurance (Sec. 79);
9) Health Savings Accounts (HSA's) (Sec. 223 and
Sec. 125(d)(2)(D); and
10) Long-term and short-term disability coverage
(Sec. 106).\2\
---------------------------------------------------------------------------
\2\ I.R.C. Sec. 125 (2006).
Additionally, an employer can offer coverage under a 401(k)
cash or deferred arrangement under a cafeteria plan.\3\
---------------------------------------------------------------------------
\3\ I.R.C. Sec. Sec. 125(d)(1)(B), (f) (2006).
---------------------------------------------------------------------------
Non-Discrimination Tests
Similar to other types of employee benefit plans, such as
401(k) plans, cafeteria plans must meet separate non-
discrimination requirements, which were created in order to
prevent benefits that are exclusively offered to ``highly
compensated'' participants and not to ``rank and file''
employees. These rules are echoed by many other places in the
Code in regards to employee benefit plans. But, Sec. 125
contains an additional non-discrimination rule which limits
non-taxable benefits to ``key employees'' to 25% of all
benefits.
These non-discrimination tests can be complicated, but they
boil down to three basic themes:
1) Eligibility - if too many rank and file employees
are excluded from participation in the plan, the plan
will be discriminatory;\4\
---------------------------------------------------------------------------
\4\ I.R.C. Sec. 125(b)(1)(A) (2006).
2) Availability of Benefits - the plan will not pass
the non-discrimination tests if the highly compensated
participants or key employees can access more benefits
or the benefits they can access are more valuable than
the benefits of rank-and-file employees;\5\
---------------------------------------------------------------------------
\5\ I.R.C. Sec. 125(b)(1)(B) (2006).
3) Utilization - a plan will not pass the non-
discrimination tests if the highly compensated
participants or key employees actually elect more
benefits under the plan than rank-and-file
employees.\6\
---------------------------------------------------------------------------
\6\ Prop. Reg. Sec. 1.125-1, Sec. 1.125-2, Sec. 1.125-5,
Sec. 1.125-6 and Sec. 1.125-7, 72 Fed. Reg. 43938 (Aug. 6, 2007).
If a cafeteria plan fails these tests, the highly
compensated participants and key employees must include these
---------------------------------------------------------------------------
otherwise tax-free benefits in their taxable income.
Highly Compensated Participants and Key Employees Defined
Section 125 contains separate definitions for highly
compensated participants and also key employees. Highly
compensated participants are defined in Sec. 125(e)(1) as a
participant who is
a) an officer;
b) a shareholder owning more than five percent of the
voting power or value of all classes of stock of the
employer;
c) highly compensated, or
d) is a spouse or a dependent of an individual
mentioned above.
Similarly, Sec. 125 defines a key employee, in reference to
Sec. 416(i)(1), and includes:
a) an officer of the employer who has an annual comp
b) a five percent owner of the employer; or
c) a one percent owner of the employer who receives
an annual compensation of more than $150,000.\7\
---------------------------------------------------------------------------
\7\ I.R.C. Sec. 416(i)(1) (2006).
Self-Employed Individuals, Partners in a Partnership and S-
---------------------------------------------------------------------------
Corp. Stakeholders
Self-employed individuals, partners in a partnership, and
2% shareholders of an S-Corporation are excluded from
participating in Sec. 125 cafeteria plans, but are still able
to sponsor plans for their employees.\8\ This is unlike
Sec. 401(c), where self-employed individuals can participate in
pension, profit-sharing and stock bonus plans along-side their
employees.\9\ And in Sec. 129, where these individuals can also
participate in dependent care assistance programs.\10\
---------------------------------------------------------------------------
\8\ Prop. Reg. Sec. 1.125-1, Sec. 1.125-2, Sec. 1.125-5,
Sec. 1.125-6 and Sec. 1.125-7 (hereinafter ``2007 proposed
regulations'' or ``2007 Prop. Reg.''), REG-142695-05, 72 Fed. Reg.
43938 (8/6/07).
\9\ I.R.C. Sec. 401(c) (2006).
\10\ I.R.C. Sec. 129 (2006).
---------------------------------------------------------------------------
Legislative History
Provisions excluding highly compensated individuals from
tax-sheltered retirement plans have been in place since 1942,
after employers sought to provide tax-sheltered retirement
benefits to ``key employees,'' including officers,
shareholders, and highly compensated employees.\11\ These ``key
man trusts'' were first introduced in 1936 and were
legislatively prohibited in the 1942 Revenue Act.\12\
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\11\ James Wooten, The Employee Retirement Income Security Act of
1974 - A Political History, 31-32 (2004).
\12\ Revenue Act of 1942, Sec. 127(a), Pub. L. No. 753, 56 Stat.
798, 825, codified as Internal Revenue Code of 1939, Sec. 23(x).
The same prohibitions against highly compensated
individuals participating in tax-sheltered retirement plans did
not extend to the payment of employee health insurance
premiums.\13\ Between 1936 and 1978, many corporations adopted
plans that reimbursed the medical expenses of shareholders and
officers, but not those of rank-and-file employees.\14\
Treasury became very concerned with these ``particularly
abusive situations,'' and singled out four closely held
corporations which reimbursed the medical expenses of
shareholder-officers as a ``way to disguise [otherwise taxable]
dividends.'' \15\
---------------------------------------------------------------------------
\13\ Daniel Schaffer & Daniel Fox, Tax Law as Health Policy: A
History of Cafeteria Plans 1978-1985, 8 Am. J. Tax Pol'y 1, 6 (1989).
\14\ Id.
\15\ Id. (citing Department of the Treasury, The President's 1978
Tax Program: Detailed Descriptions and Supporting Analysis of the
Proposals 145 (January 30, 1978), reprinted in The Presidents 1978 Tax
Reduction and Reform Proposals: Hearings Before the House Committee on
Ways and Means, 95th Cong., 2d Sess. 160, 304 (1978)).
This fear pervaded Treasury's actions through 2007. In the
introduction of the cafeteria plan legislation, Treasury
Department proposed stricter anti-discrimination rules--
specifically in regards to highly compensated individuals.\16\
Treasury feared that, without stricter anti-discrimination
rules in a cafeteria plans, higher paid employees would select
non-taxable health benefits, while lower-paid employees would
select taxable cash payments.\17\ To prevent this, Treasury's
rules were designed to ensure that lower-paid employees
actually used the available non-taxable benefits.\18\ But,
Congress did not seem to echo Treasury's fears in the Revenue
Act of 1978 - as Sec. 125 was enacted with only the provision
that ``a cafeteria plan does not discriminate where nontaxable
benefits and total benefits do not discriminate in favor of
highly compensated participants.'' \19\ Yet the legislation
left the door open for Treasury to ``prescribe such regulations
as may be necessary to carry out the provisions of this
section.'' \20\
---------------------------------------------------------------------------
\16\ Daniel Schaffer & Daniel Fox, Tax Law as Health Policy: A
History of Cafeteria Plans 1978-1985, 8 Am. J. Tax Pol'y 1, 14 (1989).
\17\ Id.
\18\ Id.
\19\ Revenue Act of 1978, Pub. L. No 95-600, Sec. 134(a), 92 Stat.
2763, 2783, codified as Internal Revenue Code of 1954, Sec. 125.
\20\ Revenue Act of 1978, Pub. L. No 95-600, Sec. 134(a), 92 Stat.
2763, 2783, codified as Internal Revenue Code of 1954, Sec. 125.
But, during the time period between 1978 to 1983, Treasury
did not issue any regulations regarding non-discrimination in
Sec. 125 plans.\21\ Thus, employers were left with the
statutory language from Congress as guidance regarding these
plans. After Treasury issued a set of proposed regulations in
1984 in the form of questions and answers,\22\ Congress, as
part of the Tax Reform Act of 1984 (``TRA'') addressed some of
Treasury's concerns regarding cafeteria plan non-discrimination
issues by adding additional language defining key employees and
the benefits that can be received by these employees.\23\ The
TRA prohibited plans that favored the highest paid officers and
owners--key employees--especially those that received more than
25% of the total benefits provided by the plans.\24\
---------------------------------------------------------------------------
\21\ See Daniel Schaffer & Daniel Fox, Tax Law as Health Policy: A
History of Cafeteria Plans 1978-1985, 8 Am. J. Tax Pol'y 1, 31-37
(1989).
\22\ 49 Fed. Reg. 19321 (May 7, 1984).
\23\ Tax Reform Act of 1984, Pub. L. No. 98-369, Sec. 53, 98 Stat.
494, codified as Internal Revenue Code of 1954, Sec. 125.
\24\ Tax Reform Act of 1984, Pub. L. No. 98-369, Sec. 53(b)(2), 98
Stat. 494, codified as Internal Revenue Code of 1954, Sec. 125(b)(2).
This addition of this key employee provision in the TRA
disproportionately affected the ability of small firms to offer
cafeteria plans. In a large firm, a key employee could still be
offered significant benefits through a cafeteria plan without
exceeding the 25% threshold. On the other hand, in a small
firm, even limited benefits provided to a key employee could
quickly exceed the 25% threshold.\25\
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\25\ See, e.g., Testimony of Hon. Frank S. Swain, Chief Counsel for
Advocacy, U.S. Small Business Administration, Hearing on the Small
Business Retirement and Benefit Extension Act S. 1426, October 23, 1987
(https://www.finance.senate.gov/imo/media/doc/hrg100-518.pdf).
Then, in 2007 the Internal Revenue Service issued proposed
regulations which finally enacted a test that ensured that
lower-paid employees actually used the available non-taxable
benefits.\26\ Specifically, the 2007 proposed regulations
provide that:
---------------------------------------------------------------------------
\26\ Prop. Reg. Sec. 1.125-7, 72 Fed. Reg. 43938 (Aug. 6, 2007).
a cafeteria plan does not discriminate with respect
to contributions and benefits if either qualified
benefits and total benefits, or employer contributions
allocable to statutory nontaxable benefits and employer
contributions allocable to total benefits, do not
discriminate in favor of highly compensated
participants. A cafeteria plan must satisfy this
paragraph . . . with respect to both benefit
availability and benefit utilization. Thus, a plan must
give each similarly situated participant a uniform
opportunity to elect qualified benefits, and the actual
election of qualified benefits through the plan must
not be disproportionate by highly compensated
participants (while other participants elect permitted
taxable benefits.\27\
---------------------------------------------------------------------------
\27\ Prop. Reg. Sec. 1.125-7, 72 Fed. Reg. 43938 (Aug. 6, 2007)
(emphasis added).
Later, in 2010, as part of the Patient Protection and
Affordable Care Act (the ``PPACA'' or the ``ACA''), Congress
relaxed the nondiscrimination requirements for Sec. 125
Cafeteria plans for small employers with under 100
employees.\28\ Specifically, the ACA provided for ``simple
cafeteria plans'' which provided employers a safe harbor from
the nondiscrimination requirements of cafeteria plans and any
nondiscrimination requirements for any of the benefits provided
under a cafeteria plan.
---------------------------------------------------------------------------
\28\ Pub. L. No 111-148.
---------------------------------------------------------------------------
Conclusion
Since 1978, Treasury and Congress have focused on
preventing the abuse of cafeteria plans by owners of closely
held corporations due to fears from particular abuses by
corporations in 1978. Congress has provided small employers
with relaxed nondiscrimination requirements in simple cafeteria
plans through the ACA in 2010. However, self-employed
individuals, partners in a partnership, and 2% shareholders of
an S-Corporation may only sponsor these cafeteria plans today,
but cannot participate in these plans.
Testimony to the U.S. House of Representatives
Committee on Small Business
Subcommittee on Economic Growth, Tax, and Capital Access
March 16, 2017
Prepared by Paula A. Calimafde, Esq.
Chair of the Small Business Council of America
President and General Counsel of the Small Business Legislative
Council
The Small Business Council of America (SBCA) and the Small
Business Legislative Council (SBLC) appreciate the opportunity
to submit testimony to the House of Representative's Committee
on Small Business Subcommittee on Economic Growth, Tax and
Capital Access.
The SBCA is a national nonprofit organization which for 38
years has represented the interests of privately-held and
family-owned businesses on federal tax, health care and
employee benefit matters. The SBCA, through its members,
represents well over 30,000 successful enterprises in retail,
manufacturing and service industries, virtually all of which
provide health insurance and retirement plans for their
employees. The SBCA is fortunate to have many of the leading
small business advisors in the country on its Board and
Advisory Boards, many of whom are the leading experts in the
tax and health care laws and how those laws impact small and
family-owned businesses.
The SBLC is a 40-year-old, permanent, independent coalition
of approximately 50 trade and professional associations that
share a common commitment to the future of small business. SBLC
members represent the interests of small businesses in such
diverse economic sectors as manufacturing, retailing,
distribution, professional and technical services,
construction, transportation, and agriculture. SBLC policies
are developed by consensus among its membership.
I am a long time member of the Employee Benefits Council of
the U.S. Chamber of Commerce and a partner in the Bethesda law
firm of Paley Rothman where I am a senior benefits and tax
lawyer. In this rule, I have counseled hundreds of small
businesses on employee benefits.
----------------------------------------------------------
--
Introduction:
Cafeteria plans (also known as IRC Section 125 plans) are a
unique and extremely valuable system for delivering benefits to
employees. Such plans allow participants to pay for certain
types of limited-scope health coverage, dependent care costs
(IRC Section 129), adoption expenses (IRC Section 137), paid
time off and out-of-pocket medical expenses (IRC Section 105)
on a pre-tax basis. Cafeteria plans can allow employees to
obtain and pay for, on a pre-tax basis, employee benefits, such
as deductibles, co-pays, prescription drugs, braces, glasses
and other health care expenses, as well as, dependent care
costs, contributions to health savings accounts (HSAs) and
401(k) accounts, disability income plans and group term life
insurance. Cafeteria plans currently provide many Americans
with greater access to health services, while allowing them to
select the benefits that they need the most. While employers
determine the benefits to be offered under a cafeteria plan,
employees have the flexibility to select only the particular
benefits that are of greatest value to them. Thus, flexibility
in the selection of benefits and affordability through the use
of pre-tax dollars are the hallmarks of the cafeteria plan.
Unfortunately, cafeteria plans are still not widely offered
by small businesses. While the enactment of legislation in 2010
creating the SIMPLE Cafeteria Plan went a long way towards
making it easier for small business owners to sponsor cafeteria
plans, the fact that small business owner-employees still
cannot participate in their businesses' plans continue to be a
significant impediment to the growth of cafeteria plan
sponsorship amongst small businesses.
While employees of most large and mid-sized businesses as
well as non-profits, schools, universities and the federal
government can take advantage of the valuable benefits provided
by cafeteria plans, most small business owners are not allowed
to participate in a cafeteria plan. Specifically, cafeteria
plans can be utilized by common-law employees, but not by sole
proprietors, partners in a partnership, S-corporation
shareholders holding an interest of 2% or greater (and by
attribution, their family members) and members in a limited
liability company that has elected to be taxed as a
partnership. According to recent data from the U.S. Small
Business Administration (SBA), seventy-three percent of small
employers are sole proprietorships, partnerships or S-
corporations--meaning, that almost three-quarters of small
business owners are excluded from participating in a cafeteria
plan.\1\ Because of this, small business owners are less likely
to take on the cost and effort of sponsoring a cafeteria plan
which deprives the small business employees of the opportunity
to obtain greater health coverage and other valuable employee
benefits that are generally available to their counterparts
working for larger businesses or in the public sector.
---------------------------------------------------------------------------
\1\ Frequently Asked Questions, U.S. Small Business Administration,
Office of Advocacy (June 2016), available at https://www.sba.gov/sites/
default/files/advocacy/SB-FAQ-2016--WEB.pdf.
---------------------------------------------------------------------------
Why Small Business Employees Need Cafeteria Plans:
Perhaps the single most important benefit that a cafeteria
plan can offer an employee is the ability to use pre-tax
dollars to pay for group health insurance premiums. The
majority of small businesses with ten or more employees offer
employees the opportunity to enroll in group health
insurance.\2\ However, it is very rare for a small business to
pay the full cost of the premiums for group health insurance
for its employees and their spouses and dependents. When a
business sponsors group health coverage but does not pay the
entire premium, the portion of the premium paid for by the
employees can only be paid with pre-tax dollars if the business
sponsors a cafeteria plan and offers health insurance as a
benefit under that plan (this is commonly known as a ``premium
conversion'' plan). If the business does not have a cafeteria
plan, employees must use after-tax dollars to pay for their
portion of the premiums. The pre and post-tax distinction, is
particularly important in the context of small businesses that
often face higher insurance premiums because they lack the same
bargaining power as larger businesses.
---------------------------------------------------------------------------
\2\ According to recent date from the Employee Benefit Research
Institute (EBRI), 73.5% of businesses with 25-99 employees, 48.9% of
businesses with 10-24 employees and 22.7% of businesses with fewer than
10 employees, offer health benefits in 2015. Notes, Employee Benefit
Research Institute (EBRI), Vol. 37, No. 8 (July 2016).
Looking more broadly, also of great significance to small
business employees is the fact that cafeteria plans can allow
small businesses to offer employees a wider swath of benefits
that more closely resemble what is commonly available to
employees of larger companies. Even if a cafeteria plan is an
employee pay all plan (meaning that the employer sets up the
plan but doesn't make contributions into it), by allowing
employees to pay for premiums and other costs pre-tax, such
plans help employees and their families afford health and other
benefits that they may not otherwise be able to afford if they
were paying for the benefits on an after tax-basis. A
comprehensive cafeteria plan can offer employees benefits that
not only help the employees individually but that also can have
broader positive social impact by allowing employees to better
protect and care for themselves and their families. For
example, cafeteria plans often offer dependent care spending
accounts to help employees pay for child care and elder care on
a pre-tax basis. Particularly as the working population and
their parents continue to age, this will be become an
increasingly important benefit for helping ensure quality of
life in old age (which is why we argue below that the dependent
care limits should be increased). Additionally, through a
cafeteria plan, employees can use their own money to secure
themselves against unexpected or otherwise uninsured medical
expenses. Flexible spending accounts (FSAs) allow employees to
pay for medical expenses not covered by insurance (such as
glasses or braces) and supplemental insurance plans (such as
those offered by Aflac) can help protect employees financially
in the event of significant medical events that may not be
fully covered by medical insurance plans, such as cancer,
accidents, or hospitalization. Above all, cafeteria plans allow
employees to mix and match the benefits they need most at
prices they could not otherwise get. Perhaps just as important,
by pre-selecting the benefit programs for the employees, the
employer makes it much easier for the employees to pick up
needed programs that they may otherwise not have taken the time
---------------------------------------------------------------------------
to find or even be aware of on their own.
Why Small Business Owner-Employees Need Cafeteria Plans:
It is no surprise that many more small business employees
are offered qualified retirement plans than are offered
cafeteria plans since small business owner-employees of pass-
through entities are eligible to participate in retirement
plans. Small business owners are inevitably less motivated to
implement a benefit they can't participate in than one that
they can. This is not because small businesses don't care about
their employees. Particularly in the early years, most small
business owners are focused on the challenges of maintaining
and growing their businesses. According to the SBA, only about
half of new businesses survive their first five years and only
about a third of new businesses survive 10 years or more.\3\ No
matter how much a business cares about its employees, offering
a benefit like a cafeteria plan comes down to a cost benefit
analysis.
---------------------------------------------------------------------------
\3\ Frequently Asked Questions, U.S. Small Business Administration,
Office of Advocacy (June 2016), available at https://www.sba.gov/sites/
default/files/advocacy/SB-FAQ-2016--WEB.pdf.
Non-owner small business employees are not the only ones
who need the benefits that can be provided through a cafeteria
plan. Many closely held small business owners and their
families make personal financial investments and sacrifices to
keep their businesses going while knowing that they may not be
able to sell the business in the event of an unexpected or
catastrophic situation. A number of the benefits that can be
offered in a cafeteria plan, such as life insurance and
voluntary supplemental health benefits, could help small
business owners protect themselves and their families and
ensure the financial stability necessary to allow them to
continue to run and grow their businesses. Accordingly, if
given the opportunity to participate in a cafeteria plan, many
small business owners would view the administrative expenses
and burdens of setting up the plan for the entire business as a
small price to pay to allow them to obtain the benefits
---------------------------------------------------------------------------
available in such a plan.
In short, while some small business owners today might
provide a premium-only plan for the non-owners, which would at
least allow employees to pay their portion of the health
insurance premium on a tax-free basis it would be highly
unlikely that the employees would be covered under a more
comprehensive cafeteria plan offering vision and dental
benefits, flexible health care spending accounts, dependent
care flexible spending accounts, additional life insurance and
so on. However, if small business owner-employers were allowed
to participate in the cafeteria plan, the likelihood of their
sponsoring a comprehensive cafeteria plan would increase
significantly--meaning that more small business employees would
have the opportunity to take advantage of this valuable
benefit.
Current Treatment of Small Business Owners and Cafeteria
Plans:
IRC Section 125 does not specifically include self-employed
individuals in its definition of ``employee.'' Based on this,
the Internal Revenue Service has taken the position that
Congress intended to exclude owner-employees of small and
closely held businesses from being ``employees'' for purposes
of IRC Section 125. We contend that Congress did not intend
such result because, at the time Section 125 was enacted, small
business owner-employees, regardless of what type of entity
they were working for (a pass-through or otherwise), were
deemed employees for purposes of qualified retirement plans.
Regardless, this is the current IRS position and we've been
assured time and time again by officials at the Treasury and
IRS that absent legislation to the contrary, they will maintain
this position. This is plain and simple discrimination against
small business owners.
This rule is also bizarre in light of the fact that small
business owner-employees are, of course, allowed to participate
in qualified retirement plans. There is no good reason to think
that small business owner-employees should be treated
differently for a similar type of employee benefit--the
cafeteria plan--particularly given that everybody else can be
covered by a cafeteria plan. As a result of IRS' interpretation
of Section 125, sole proprietors, partners, shareholders owning
2% or more in S-corporations, and members of most limited
liability companies are all unable to participate in cafeteria
plans. As mentioned above, this is a significant disincentive
for small business owners to provide cafeteria plans for their
employees.
Recommendations for Improving the Cafeteria Plan System:
First and foremost, owner-employees of small and closely
held businesses should be permitted to participate in cafeteria
plans and the variety of benefits that can be offered through a
cafeteria plan. To achieve this, we urge Congress to pass
legislation to: (1) modify 26 U.S.C. Sec. 125 to make it clear
that self-employed individuals, including sole proprietors,
partners, S-corporation shareholders and members in a limited
liability company that has elected to be taxed as a
partnership, are deemed to be employees for the purpose of
eligibility to participate in a cafeteria plan and (2) modify
the statutes governing the specific benefits that can be
included in a cafeteria plan, including 26 U.S.C. Sec. 79 (life
insurance and accidental death), 26 U.S.C. Sec. Sec. 105-106
(medical, dental, vision, short- and long-term disability), and
possibly 26 U.S.C. Sec. 129 (dependent care), to make it clear
that self-employed individuals (i.e., owner-employees) are
deemed to be employees for the purposes of eligibility to
participate not just in the cafeteria plan itself but in the
specific benefits that may be offered through the cafeteria
plan.
Additionally, we would argue that the limits on how much a
cafeteria plan participant can contribute tax-free towards a
flexible spending account (FSA) or dependent care are too low
and need to be increased in order for these to be truly
meaningful benefits for employees. The 2017 FSA contribution
limit is $2,600 and the dependent care contribution limit is
$5,000 (or $2,500 for married filing separately). The very low
limits on FSAs were placed into the law as a revenue raiser for
the Affordable Care Act and are so low as to almost be absurd.
The limit on dependent care is not subject to COLA and has been
$5,000 for the last 35 years! It is simply not realistic to
think that employees can get quality child care or elder care
today for $100 a week. According to data from the Economic
Policy Institute, the average annual cost for infant care
exceeded $5,000 in 49 out of 50 states (often by thousands of
dollars) and the average annual cost for care for a four year
old exceeded $5,000 in 43 out of 50 states.\4\ Moreover,
according to MetLife's 2012 Market Survey of Long-Term Care
Costs, the average national cost for adult day care services is
$71 per day (or over $25,000 per year).\5\ We urge Congress to
pass legislation to increase and index the contribution limits
for FSAs and dependent care accounts so that they better
reflect the true costs that employees are facing.
---------------------------------------------------------------------------
\4\ Child Care Costs in the United States, Economic Policy
Institute, available at http://www.epi.org/child-care-costs-in-the-
united-states/.
\5\ Market Survey of Long-Term Care Costs, MetLife (2012),
available at https://www.metlife.com/mmi/research/2012-market-survey-
long-term-care-
costs.html?WT.ac=PRO--Pro3--PopularContent--
5-18491--T4297-MM-
mmi&oc--id=PRO--Pro3--PopularContent--
5-18491--T4297-MM-mmi#keyfindings.
Finally, particularly as the population ages and the stress
on the social systems supporting the elderly increases, we
believe that it would be desirable to allow cafeteria plans to
be able to provide employees with the option of purchasing
long-term care insurance as a qualified benefit. If allowed to
purchase long-term care insurance on a pre-tax basis and by
payroll deduction, it is far more likely that employees will
elect to be covered by long-term care. Encouraging citizens to
finance their own long-term care is desirable as it will help
to shift the burden away from the government in addressing the
long-term care needs of older citizens. The entire country wins
when Congress can incentivize individuals to purchase long-term
care insurance on their own. We urge Congress to pass
legislation to consider modifying 26 U.S.C. Sec. 125 to remove
the exclusion for long-time care insurance and allow long-term
care insurance to be a qualified benefit that may be offered
---------------------------------------------------------------------------
through a cafeteria plan.
Most importantly, it is essential to treat owner-employees
of pass-through entities as employees for all of these employee
benefits. It is blatant discrimination against small business
owner-employees to prohibit them from using these plans just
because they have chosen to operate their businesses as a pass-
through entity. By making this change, it is far more likely
that the valuable world of cafeteria plans will be made
available to all small business employees so they will have
parity with their counterparts who work for the government or
who work for entities operating as a C corp regardless of the
size of the company. Enactment of the SIMPLE cafeteria plan was
a significant step forward in assisting small businesses with
sponsoring cafeteria plans but without allowing owner-employees
to participate in the plan, it will not accomplish its purpose
of expanding this valuable plan for all small business
employees.
Elise Feldman Testimony for The Committee on Small Business
Subcommittee on Economic Growth, Tax, and Capital Access, Hearing
titled ``Cafeteria Plans: A Menu of Non-Options for Small Business
Owners
Thursday, March 16, 2017
Room 2360 Rayburn House Office Building
My name is Elise Feldman, President of Feldman Benefit
Services, Inc. with offices in Springfield, New Jersey and Boca
Raton, Florida. I am a Certified Pension Consultant and
Accredited Investment Fiduciary. I also own Outsource, Inc., a
Human Resources consulting firm. I am most pleased to be
sharing my testimony with the Committee and thank you for
inviting me to do so.
Our firm is a full-service actuarial and employee benefits
company, which clients are small to mid-sized businesses,
ranging in size from 1 - 3,000 employees. The majority are
closely owned, generally 1 - 10 owners and under 100 employees
(unless a professional service firm such as accounting or legal
which would have more partners.)
We have approximately 350 clients. The primary services we
provide are in regard to qualified retirement plans. In
addition, we provide services for non-qualified deferred
compensation plans and certain welfare benefit plans. We either
provide ``full service'' or consulting services for Section 125
Cafeteria Plans.
The Section 125 Plan services include annual testing
(eligibility, key employee and concentration tests), annual
compliance letters, and for those with flexible spending
accounts, we provide reimbursement handling. When over 100
employees, we prepare the 5500 Annual Reporting Forms. Through
providing these services, I have seen first-hand how the
existing laws and regulations that apply to cafeteria plans
impact the decisions that small business owners make with
respect to the benefit that they offer.
As a result of current laws and regulations, owner-
employees cannot participate in a Section 125 plan they sponsor
for their employees unless they are a C Corporation. Very few
small business are organized as C-Corporations. Rather small
businesses tend to be organized as Sub Chapter S Corporations,
LLCs or LLPs. Our small business clients tend to have a
``paternalistic'' attitude towards protecting their employees,
as they recognize the business would not be as successful were
it not for their efforts. As a result, these employers want to
offer benefits to their employees. In addition to other
benefits they may provide, the most common (and, to employees,
perhaps the most valuable) benefit that our clients tend offer
is health insurance, though with a premium sharing arrangement,
with the employer paying part of the premium and the employee
paying the rest. However, if the business does not sponsor a
Section 125 plan, the employees will only be able to pay their
portion of the premium with after-tax dollars. Thus, it makes
good financial sense to encourage small businesses to sponsor
Section 125 plans which can allow, among other things, the
employees to pay their share of premium on a pre-tax basis.
In addition to health insurance premium payments, those
employers that sponsor Section 125 plans can make a number of
other benefits available to employees, such as the Medical
Reimbursement benefit as well as the Dependent Care benefit.
These benefits give the employees an opportunity to provide
better health care for themselves and their family members,
because the Section 125 plan structure enables the employees to
do so more easily and more affordably (because the
contributions are made on a pre-tax basis). The option to take
advantage of these benefits is generally appreciated by the
employees.
However, while sponsoring a Section 125 plan can be good
for employees, under current law, small businesses owners who
incur the expense and administrative burden of setting up a
plan must do so with the understanding that they will not be
able to participate in the plans themselves. For these owner-
employees, their ability to utilize the benefits, most
importantly the medical reimbursement and dependent care
provisions, is solely because of their small size and form of
entity. Had these individuals been employees and not owners, or
had the business been a C-Corporation this would not be the
case.
I would like to give you an example: On Monday, I had a
meeting with an attorney in my office building, and I mentioned
that I was coming here today. He then mentioned that his wife
did not believe him when he told her he could not be in one of
these plans.
Interestingly, even if the lawyer had been allowed to
participate in the plan, assuming he was not an owner of a
pass-through entity, he would have only been allowed very few
benefits in the plan because of the onerous discrimination
tests imposed on cafeteria plans (absent the firm adopting a
SIMPLE cafeteria plan). For instance, if I and my company's
Actuary who is also an owner, were allowed to participate in
our cafeteria plan, the discrimination tests would fail.
Correction by lowering the amount the two owners put in would
enable it to pass the concentration test. Alternatively, if we
were allowed to participate, we could decide to change to the
SIMPLE cafeteria plan which would require the company to put in
contributions for our employees, but in exchange we would not
be required to do the overly complex and frankly unfair tests
imposed by the cafeteria plan rules on small businesses.
Because the law firm upstairs has more owners and fewer
employees, the way the testing works in the context of a small
business would have cause their testing results to not come in
as well as my company's and the contributions for the owner-
employees would have been far more restricted.
Each year, as we offer Section 125 services for our
clients, we get the same routine questions from both the
employer and employees.
The owner-employee asks ``when will I be able to
participate?'', as well as ``when will we be able to offer
over-the-counter medications again?''
As the medical and pharmaceutical industries have now
adjusted so that medications which were previously only
available by prescription can now be obtained over the counter,
the financial dynamics have changed. Eye drops, allergy, and
stomach medications, to only name a few types, must be paid for
with after-tax dollars. Restoring the pre-tax benefit for over
the counter medications would enable employees do better afford
their medications. Employees who feel better, work better, are
healthier, and more productive.
Lastly, employees ask if there will be any significant
increases to both the annual medical reimbursement and
dependent care limits. Health care costs continue to rise. More
dual income families are now in the workforce, and the cost of
providing child care has continued to increase. The dependent
care limits, however, have remained unchanged since the 1980's.
Increasing the amount that employees can contribute to their
Section 125 plans for these purposes will help employees cover
these necessary costs.
I welcome the opportunity to answer your questions.
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
The U.S. Chamber of Commerce is the world's largest
business federation representing the interests of more than 3
million businesses of all sizes, sectors, and regions, as well
as state and local chambers and industry associations. The
Chamber is dedicated to promoting, protecting, and defending
America's free enterprise system.
More than 96% of Chamber member companies have fewer than
100 employees, and many of the nation's largest companies are
also active members. We are therefore cognizant not only of the
challenges facing smaller businesses, but also those facing the
business community at large.
Besides representing a cross section of the American
business community with respect to the number of employees,
major classifications of American business--e.g.,
manufacturing, retailing, services, construction, wholesalers,
and finance--are represented. The Chamber has membership in all
50 states.
The Chamber's international reach is substantial as well.
We believe that global interdependence provides opportunities,
not threats. In addition to the American Chambers of Commerce
abroad, an increasing number of our members engage in the
export and import of both goods and services and have ongoing
investment activities. The Chamber favors strengthened
international competitiveness and opposes artificial U.S. and
foreign barriers to international business.
Statement on
Cafeteria Plans: A Menu of Non-Options for Small Business
Owners
Hearing before
The Subcommittee on Economic Growth, Tax, and Capital Access
of the
House Small Business Committee
on behalf of the
U.S. CHAMBER OF COMMERCE
March 16, 2017
The U.S. Chamber of Commerce would like to thank Chairman
Brat, Ranking Member Evans, and members of the Subcommittee for
the opportunity to provide a statement for the record. The
topic of today's hearing--cafeteria plans and the lack of
options for small business owners--is of significant concern to
our membership.
The Chamber very much supports the statement given during
the March 16, 2017 hearing by Paula Calimafde, who is an active
and long-standing member of the Employee Benefits Committee of
the U.S. Chamber of Commerce. Specifically, we concur with Ms.
Calimafde's recommendations to permit owner-employees to
participate in cafeteria plans.
A significant portion of Chamber membership is made up of
small businesses. While many of these small businesses offer
substantial benefits to their employees, they should be
encouraged and--at the very least--not discouraged from
offering as wide an array of benefits as possible. However,
when it comes to cafeteria plans, small business owners are at
a significant disadvantage and, therefore, it discourages them
from implementing cafeteria plans for their employees.
Consequently, we urge Congress to allow small business owners
to participate in cafeteria plans and, thereby, encourage the
expanded implementation of cafeteria plans by small businesses.
Introduction
Cafeteria plans are governed by IRS Section 125 which
allows employees to make contributions to designated accounts
before taxes are calculated; thereby, providing workers an
opportunity to receive certain benefits on a pretax basis.
Benefits provided under cafeteria plans include health
insurance, disability insurance, life insurance, 401(k) plan
contributions, dependent care assistance, adoption assistance,
and contributions to Health Savings Accounts (HSAs).
Discussion
Small Business Owners Should be allowed to Participate in
Cafeteria Plans. Sole proprietors, partners, members of limited
liability companies and most stockholders in a Sub-S
corporation are not allowed to participate in a cafeteria plan.
These types of entities represent a significant portion of
American business--approximately 78% of all non-farm businesses
are organized in a manner under which the owners of the
business are not permitted to participate in a business
sponsored cafeteria plan. This rule clearly discriminates
against business owners/employees based solely upon the type of
entity in which they are operating their business.
Since they are not able to participate, owners are
discouraged from implementing cafeteria plans. Because these
entities choose not to sponsor a cafeteria plan, their
employees do not have the opportunity to participate in a
cafeteria plan. Therefore, changing this law would increase
opportunities for not just business owners to benefit from
cafeteria plans, but also their employees.
Consequently, we urge Congress to pass legislation to
modify IRS section 125 to make it clear that self-employed
individuals, including sole proprietors, partners, S-
corporation shareholders and members in a limited liability
company that has elected to be taxed as a partnership, are
deemed to be employees for the purpose of eligibility to
participate in a cafeteria plan. Moreover, such language should
also make it clear that self-employed individuals are deemed to
be employees for the purposes of eligibility to participate not
just in the cafeteria plan itself, but in the specific benefits
that may be offered through the cafeteria plan.\1\
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\1\ The Chamber supported S. 555 - (110th Congress) the SIMPLE
Cafeteria Plan Act of 2007 and encourages Congress to move forward with
similar legislation.
Congress Should Encourage Expansion of the Types of
Benefits That Can be Provided in a Cafeteria Plan. Long-term
care insurance is specifically excluded from the list of
qualified benefits under a cafeteria plan.\2\ However, there
are increasing concerns about long-term care. The number of
Americans in need of long-term care services, either at home or
in institutions, is projected to increase from 12 million today
to 27 million by 2050, and 70% of people who reach age 65 will
require long-term care services at one point in their lives.\3\
Moreover, 45% of Americans ages 40 and older have provided
long-term care for a family member or close friend at some
point.\4\ Paying for long-term care can be prohibitively
expensive. Long-term care costs after age 65 is estimated to be
about $138,000.\5\ These rising costs are particularly
troubling because families will pay about half of the total
share of long-term care costs through out-of-pocket spending,
which can be a drain on personal savings, retirement accounts,
and other assets.\6\ About the other half (44.8%) of these
long-term costs will be borne by government programs,
particularly Medicaid and Medicare.\7\
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\2\ Code section 125(f)(2).
\3\ Bipartisan Policy Center, Long-Term Care Initiative,
``America's Long-Term Care Crisis: Challenges in Financing and
Delivery,'' (April 2014), available at https://bipartisanpolicy.org/
library/americas-long-term-care-crisis/.
\4\ Associated Press-NORC Center for Public Affairs Research,
``Long-Term Care in America: Americans' Outlook and Planning for Future
Care,'' (July 2015), available at http://www.longtermcarepoll.org/
Pages/Polls/long-term-care-in-america-americans-outlook-and-planning-
for-future.aspx. Among those with experience providing care for a
family member or friend, 19% are currently providing assistance and 65%
have household incomes less than $75,000 a year.
\5\ Melissa Favreault and Judith Dey, U.S. Department of Health and
Human Services, Office of Disability, Aging, and Long-Term Care Policy,
``Long-Term Services and Supports for Older Americans: Risks and
Financing,'' ASPE Issue Brief, (July 2015), available at http://
aspe.hhs.gov/sites/default/files/pdf/106211/
ElderLTCrb--0.pdf.
\6\ Id.
\7\ Id.
Long-term care insurance policies are more affordable and
accessible when the applicant is below retirement age. The cost
of a basic policy with average benefits is $1,725 a year for a
45-year-old; however, the same policy for a 65-year-old is
double that amount, at $3,451 a year.\8\ To help pay for these
premiums while they are affordable, the Chamber recommends that
employers be allowed to offer long-term care insurance through
a cafeteria plan.
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\8\ Long-Term Care Insurance Premium Sample, available at http://
www.guidetolongtermcare.com/premiumsample.html.
While longevity insurance is not specifically excluded, it
would be helpful if Congress could encourage the inclusion of
this benefit in cafeteria plans. As we are aware, life
expectancy is increasing. While living longer is a great thing,
it can create challenges for retirement security. The most
obvious longevity challenge is outliving one's retirement
savings. In 2015, life expectancy at birth was 78.8 years for
the total U.S. population.\9\ This represents an increase of
approximately 30 years since 1900 and 8 years since 1971.\10\
Moreover in 2015, life expectancy at age 65 for the total
population was 19.4 years.\11\ Thus, workers must plan for
longer lives that could include a longer period in retirement.
To avoid this situation, a retiree could purchase longevity
insurance, a form of deferred annuity with a payment start date
that begins at a later age in retirement. Thus, individuals can
protect themselves against the financial risk of outliving
their retirement savings. An effective way to encourage the
purchase of longevity insurance is to allow employees to
purchase it through a cafeteria plan.
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\9\ Jiaquan Xu, M.D., Sherry L. Murphy, B.S., Kenneth D. Kochanek,
M.A., and Elizabeth Arias, Ph.D, ``Mortality in the United States,''
NCHS Data Brief No. 267 (December 2016), available at https://
www.cdc.gov/nchs/products/databriefs/db267.htm.
\10\ In 1900, the average life expectancy in the U.S. was 49.24
years and in 1971 it was 70.75 years. National Vital Statistics
Reports, Vol. 64, No. 11, September 22, 2015. https://www.cdc.gov/nchs/
data/nvsr/nvsr64/nvsr64--11.pdf.
\11\ Jiaquan Xu, M.D., Sherry L. Murphy, B.S., Kenneth D. Kochanek,
M.A., and Elizabeth Arias, Ph.D, ``Mortality in the United States,''
NCHS Data Brief No. 267 (December 2016), available at https://
www.cdc.gov/nchs/products/databriefs/db267.htm.
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Conclusion
We reiterate the importance of encouraging small business
owners to implement benefit plans. Changing IRS section 125 to
allow owners to participate and expanding benefits offerings
under the plan would encourage more small businesses to
implement cafeteria plans. We look forward to working with this
Subcommittee and Congress to enact legislation that will
encourage further participation by small business owners and
their employees in cafeteria plans. Thank you for your
consideration of this statement.