Compensation Plans

Flexible Compensation Plans

Tucker Administrators has designed, under Internal Revenue Service (IRS) Code Section 125, a Cafeteria Plan - sometimes known as a Flexible Compensation plan - which allows employees to be given a salary reduction option, whereby certain eligible expenses may be paid with pre-tax dollars rather than after-tax dollars.

Generally, these eligible expenses include hospital, surgical and other unreimbursed medical expenses incurred for care of the employee, his or her spouse and dependent(s). For example, a flexible compensation plan might be used to reimburse expenses applied to a deductible and co-insurance amounts. Expenses for annual physicals and preventive care, as well as dental, vision, hearing, and dependent child care expenses are also eligible.

In short, flexible compensation is one of the most innovative ideas in employee benefits today.

Advantages To The Employee

The most significant advantage of flexible compensation to an employee is the tax break. Since a flexible compensation plan uses pre-tax dollars for reimbursement of otherwise after-tax expenses, an employee reduces his Social Security, federal and state income tax base by reducing his salary and thus his taxes. In other words, the more an employee uses flexible compensation, the lower his tax base is and the more net spendable income he has.

For example, if a single person with two dependents earned $1,600 per month, the paycheck stub may look something like this:

From the net paycheck, if the employee were paying three eligible expenses, such as,

the paycheck stub may look something like this:

If the employee were paying those same three expenses with before-tax, rather than after-tax dollars, the paycheck stub, by comparison, may look something like this:

	The gross income (that income on which federal and state taxes are paid) has gone down from $1,600.00 to $1,190.00. That's because eligible flexible compensation expenses (in this case, dependent medical premium, unreimbursed medical expenses and child care expenses) were paid first with pre-tax dollars.
	Federal and state taxes went down from $266.65 to $176.45 and social security from $122.40 to $91.04.
	Because eligible expenses were paid under flexible compensation, the employee in this illustration had a net pay raise from $800.95 to $922.51, or $121.56 per month, - $1,458.72 per year - all because of flexible compensation.
	Employees can now have the same flexible compensation advantages that employees of large corporations like Exxon, Pepsi-Cola, Chemical Bank, Quaker Oats, Marriott, Morgan Guaranty Bank, B.F. Goodrich, Motorola, Alcoa and many others have.

Advantages To The Employer

Through an employee-funded flexible compensation plan, both the employer and employee stand to receive substantial payroll tax relief. Since employee salaries are being reduced, Social Security and unemployment compensation insurance are also reduced, thus lowering employer payroll taxes. Here's how it works.

Assuming the effective employer's unemployment insurance is about 2.35% combined, added to the 7.65% Social Security tax, the total employer payroll tax is about 10% percent. Federal unemployment insurance is assessed only on the first $7,000 of wages.

For the sake of illustration, if all your employees earned $1,600.00 per month and installed flexible compensation to reduce their gross from $1,600.00 to $1,190.00 monthly, your payroll tax would be 10% of the $1,190.00, or $119.00, rather than 10% of $1,600.00, or $160.00. This would be a savings of $41.00 per month per employee, or $492.00 per year per employee. $492.00 times the number of employees in your company potentially saves you several thousand dollars each year the plan is in effect.

You not only save on payroll taxes, but your employees also receive attractive and unexpected net pay raises. All flexible compensation participants can have net pay raises - because of you.

Another advantage to the Tucker Administrators flexible compensation plan is the potential for cost containment. This can be especially helpful to employers who are considering plan design changes, such as increased deductibles and co-insurance. While these type of changes shift some of the cost to employees and encourage wise use of health care benefits, many employers hesitate to use these measures because of potential negative reaction by their employees. Tucker Administrators flexible compensation plan can lessen the impact of cost shifting by giving employees a way to cover some of the increased out-of-pocket expenses.

We realize that salaries and degree of participation will vary up or down from this example. It is designed only to illustrate the potential employer savings under these conditions. True savings will depend on actual enrollment and pre-tax allocated expense payments designated by each plan participant.

How does Flexible Compensation Work?

A company setting up a flexible compensation plan will contract with Tucker Administrators to establish and maintain certain administrative systems and procedures. Flexible compensation plans require claims processing, payroll and accurate recordkeeping. The plan needs to be established as required by the Internal Revenue Code and other Federal legislation. Each claim must be screened before reimbursement to determine whether it is covered under the plan. While there are administrative expenses involved in providing a flexible compensation plan, they are paid for entirely by the employer.

An account record will be established and maintained for each plan participant. "Deposits" will be recorded and the balance checked for each reimbursement.

When an employee incurs an eligible expense, he or she completes a "Request for Reimbursement" form and submits it to Tucker Administrators for payment. Tucker Administrators processes the request, determining the eligibility of the expense and the availability of funds based on the employee's account balance. A check is then drawn on your company's trust account and sent to the employee.

The following example will give an operational overview of the flexible compensation plan concept and has been simplified in order to present the concept more easily:

In January an employee decides to set aside $50 a month ($600 annually) in his flexible compensation account. In March, the employee goes to the dentist for a check-up and also purchases prescription eyeglasses. The total charge for the check-up is $35, while glasses are $175. His dental plan carries a $50 deductible and does not cover vision care. He pays the $210 total and then requests reimbursement under his account. At the time, the employee has $450 in his account. Both expenses - the $35 of his deductible and the $175 not covered under the plan - are eligible under his flexible compensation account. He receives the $210 from Tucker Administrators to reimburse him for his expenses and his account is reduced accordingly.

Tax Aspects

Definition of Flexible Compensation Plans

As defined in IRS Section 125, a flexible compensation plan means a written plan under which all participants are employees, and the participants have the choice among two or more benefits. The benefits which may be chosen must be certain statutory non-taxable benefits pursuant to the 1984 Deficit Reduction Act (DRA) and cash.

The term flexible compensation plan does not include any plan which provides for deferred compensation. This, however, does not apply in the case of a profit-sharing or stock bonus plan which includes a qualified cash or deferred arrangement (as defined in Section 401 (k) (2) to the extent of amounts which a covered employee may elect to have the employer pay as contributions to a trust under such plan on behalf of the employee.

Eligible Benefits

To qualify as a flexible compensation plan, the plan must restrict the employee's choice of benefits to certain statutory non-taxable benefits and cash:

1.	Cash
2.	Taxable group-term life insurance in excess of $50,000
3.	Group term insurance to $50,000
4.	Reimbursement for qualifying medical expenses
5.	Payment of health insurance premiums for employee or dependents (including premiums for personal dental insurance)
6.	Qualifying dependent child-care services
7.	Vacation days which cannot be cashed in
8.	Contributions to 401 (k) plans

Non-taxable benefits which are specifically prohibited as options in a plan include scholarships, vanpooling, education assistance programs, and the once non-statutory fringe benefits now codified under Section 132 (such as "no-additional-cost," "working condition," "qualified employee discount," and "de minimus" fringes).

Funding Through Salary Reduction

Either employee-funded (through salary reduction) or employer-funded benefits may be offered in a flexible compensation plan. However, only salary reduction funding results in a "real" tax savings to the employee or employer. Employer-funded benefits may just as easily be provided outside of the plan.

Section 125 Regulations

Highlighted provisions of the regulations include the following:

1.	Salary reduction is expressly permitted as a means of funding flexible compensation plans.
2.	Before the beginning of the plan year, an advance election must be made by the employees as to the amount of salary to be allocated to each benefit account (e.g., health care, dependent care). The election is irrevocable, except in cases of a change in family status or change of a spouse's employment.
3.	Employees must use a benefit or lose it. Once an election is made, the amount earmarked for a particular benefit can be used only for that benefit with any excess over actual expenses being either forfeited or equally allocated to all plan participants as of the year end. Thus, cashouts and carryovers are not permitted.
4.	Section 125 merely prevents otherwise non-taxable benefits from being taxed solely because of the doctrine of constructive receipt. It does exclude from taxation benefits which, if offered outside of a flexible compensation plan, would be fully taxable. Thus, for example, health care reimbursements must independently meet the requirements of Section 125 in order to be non-taxable when offered as an option in a flexible compensation plan. If the anti-discrimination requirements of Section 105 (h) are not met by a self-insured medical reimbursement plan, payments under the plan to a highly compensated individual as part of a flexible compensation plan will be taxable. Likewise, the anti-discrimination requirements of Section 79 (d) must be met, in addition to the discrimination guidelines under Section 125, in order for group-term insurance premiums paid on behalf of key employees to be non-taxable.
5.	If more than 25% of the total non-taxable benefits of a flexible compensation plan are provided to "highly compensated" employees, those key employees would be taxed as if they had chosen and received taxable benefits.

Plan Administration

Tucker Administrators will be responsible for establishing the plan and its daily administration. We will:

	Counsel, advise and suggest a specific set of Benefits which will accomplish your aims of the plan
	Provide consulting, data and planning to implement the plan
	Consult with employer as to contribution levels for intended benefits
	Assist in preparation of Plan Document outlining plan benefits and provisions
	Arrange for the following documents: Plan Document Summary Plan Description Booklet Administrative Services Agreement Employee Authorization Agreement Request for Reimbursement Forms Benefit Payment Checks Employee Statement of Account
	Evaluate claims data regarding eligibility for reimbursement
	Advise regarding innovations and developments in flexible compensation areas which would be helpful or of interest
	Attend periodic meetings to maintain an understanding of plan design and discuss efficient plan utilization
	Maintain appropriate supply of benefit payment checks, and other necessary administrative forms
	Establish and maintain files on each plan participant for determination of plan benefits
	Answer telephone and mail inquiries from participants
	Correspond with participants if additional claim payment information is needed
	Review marginal or questionable claims
	Process and mail claim checks
	Notify claimants of ineligible claims, indicating reason for declination
	Prepare periodic status report of plan participant account and claims summary

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