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[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
              
              
              
                             _________ 

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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

                              ----------                              

                        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\
---------------------------------------------------------------------------
    \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\
---------------------------------------------------------------------------
    \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.
```