Many employers give their employees the option to receive cash if they opt out of the employer’s health insurance coverage. It is permissible to do so, but the option must comply with IRS rules.
Cash in lieu of benefits falls under the cafeteria plan rules of Section 125 of the IRC. The employer must have a written cafeteria plan in place and the plan must have cash in lieu of the benefit coverage as one of its options. An employer cannot have cash in lieu of policy which is outside a cafeteria plan.
If the employer does not have a written cafeteria plan in place or if the employer’s cafeteria plan does not include the pay in lieu of coverage as one of its options, but the employer offers pay in lieu of coverage outside the plan, the IRS takes the position that all employees have the option to take cash or the benefit and that the employees who chose the benefit coverage and forego the cash will nevertheless be deemed to have received taxable wage income equal to the amount of the cash alternative. See, Prop. Treas. Reg. § 1.125-1, Q & A – 9; Private Letter Ruling 9406002.
In addition, the amount considered to be wages is subject to income tax withholding and FICA and FUTA payroll taxes. Further, the amount considered to be wages should be included in the employee’s “regular rate” for purposes of computation of overtime pay unless the criteria set out in the DOL Opinion Letter FLSA 2003-4 (June 2, 2003) are satisfied. Among the criteria are that the employee must show there is alternative coverage for the coverage being waived and no more than 20% of the employer’s contribution to the cafeteria plan can be paid out in cash. See, Madison v. Resources for Human Development, Inc. 39 F.Supp.2d 542 (E.D. Pa. 1999), vacated and remanded, 233 F.3d 175 (3d Cir. 2000); Prop. Regs at 72 Fed. Reg. 43939 (August 6, 2007).
Posted by Carl H. Hellerstedt, Jr. Mr. Hellerstedt is Counsel with Spilman Thomas & Battle, PLLC. His primary areas of practice are labor and employment and ERISA law.