Cafeteria plans, or flexible benefit plans, are employee benefit plans, authorized by Internal Revenue Code Section 125, under which employees may choose from among two or more benefits (consisting of cash and qualified benefits) offered by an employer. Employee deductions to fund the benefits are exempt from federal income tax, FICA, and, in some states, state income tax, withholding.
No special permission is required from the IRS to implement a cafeteria plan but the plan:
(1) must be in writing,
(2) cannot offer an option to defer compensation except through a 401(k) plan (such deferred compensation is subject to FICA withholding), and
(3) cannot discriminate in favor of highly compensated employees or key employees.
Benefits that may be offered under a cafeteria plan include accident and health insurance, dependent care assistance, group legal services, group term life insurance (although life insurance in excess of $50,000 is includible in gross income), and additional vacation days.