CEBS GBA1 - Section 125 Plans with Complete Solutions

CEBS GBA1 - Section 125 Plans with Complete Solutions What are the two primary factors that contribute to the popularity of cafeteria plans? - Correct Answer The two primary factors that contribute to the popularity of cafeteria plans (often called flexible benefit plans or flex plans) are: (1) The ever-increasing costs of benefits (2) A diverse workforce with vastly differing employee benefit needs. Permitting employees to select those benefits that are most applicable to their personal financial circumstances makes sense for both the employee and the employer. With employee benefits representing a large component of labor costs for most organizations, it is important to spend employee benefit dollars in a cost-efficient way that maximizes value. A cafeteria plan ensures that the employer maximizes the value of its benefit dollars and avoids spending money on duplicated or unneeded benefits. Before the advent of flex plans, optional or supplemental benefits were paid by the employee using after-tax dollars. A flexible benefit plan allows employees to contribute toward benefits on a tax-favored basis. As certain benefit programs have become more costly, notably health care, and more employees are asked to share costs with the employer, the tax advantages and choice in benefits selection become particularly appealing. Describe the tax doctrine of constructive receipt within the context of cafeteria plans. - Correct Answer Cafeteria plans operate as an exception to the tax doctrine of constructive receipt. Usually, when an individual has control over how money is spent, it becomes taxable to that individual. However, provided a cafeteria plan is designed in accordance with all applicable tax laws, a cafeteria plan participant can avoid taxation and instead receive tax-free benefits. Describe the concept of a cafeteria plan and how it operates in connection with other employee benefit plans sponsored by an employer. - Correct Answer A cafeteria plan operates in connection with other employee benefit plans sponsored by an employer. In fact, an essential concept in understanding a cafeteria plan is recognition that the cafeteria plan really is an umbrella plan under which tax-favored employee benefits are offered. The cafeteria plan is merely a mechanism to pay for employee benefits. Internal Revenue Code (IRC) Section 125 and the regulations related thereto govern cafeteria plan arrangements while other IRC sections apply to the underlying benefits funded within the cafeteria plan. Section 125 was added to the IRC by the Revenue Act of 1978. Prior to the enactment of this section of the IRC, the tax treatment of benefits involving participant choice was quite different. If a participant had