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24–531 2017

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 

Small Business Committee Document Number 115–009 

Available via the GPO Website: www.fdsys.gov 

SBREP-219A with DISTILLER


Congress.#13
(II) 

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 GONZA ́ LEZ-COLO ́ N, Puerto Rico 

DON BACON, Nebraska 

BRIAN FITZPATRICK, Pennsylvania 

ROGER MARSHALL, Kansas 

VACANT 

NYDIA VELA ́ ZQUEZ, 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 

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(III) 

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 

SBREP-219A with DISTILLER

SBREP-219A with DISTILLER

(1) 

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, Gonza ́lez-Colo ́n, 

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 midsized 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. 

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2 

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. Passthrough 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 

SBREP-219A with DISTILLER

3 

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. 

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4 

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, profitsharing, 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 taxsheltered 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 

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5 

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 passthrough entity they are not eligible. And I will explain in real life 

what that translates to is most small businesses do not sponsor 

SBREP-219A with DISTILLER

6 

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. 

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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 passthroughs 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 employSBREP-219A with DISTILLER

8 

ees 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 

SBREP-219A with DISTILLER

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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. 

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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 longterm 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. 

SBREP-219A with DISTILLER

11 

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 

SBREP-219A with DISTILLER

12 

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 

SBREP-219A with DISTILLER

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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. 

SBREP-219A with DISTILLER

14 

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 passthrough 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 

SBREP-219A with DISTILLER

15 

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 passthroughs, 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 

SBREP-219A with DISTILLER

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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.] 

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1David Ralsh, Cafeteria Plans, 397 TAX MGMT. PORT. (BNA) B-4 (2017). 

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 

§ 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 § 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) Accidental death and dismemberment insurance policy 

(§ 106); 

2) Accident and health benefits (§§ 105-106); 

3) Adoption assistance benefits (§ 137); 

SBREP-219A with DISTILLER

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2 I.R.C. § 125 (2006). 

3 I.R.C. §§ 125(d)(1)(B), (f) (2006). 

4 I.R.C. § 125(b)(1)(A) (2006). 

5 I.R.C. § 125(b)(1)(B) (2006). 

6Prop. Reg. § 1.125-1, § 1.125-2, § 1.125-5, § 1.125-6 and § 1.125-7, 72 Fed. Reg. 43938 (Aug. 

6, 2007). 

4) COBRA continuation coverage; (§ 106); 

5) Death and dismemberment insurance; 

6) Dependent care assistance (§ 129); 

7) Flexible Spending Arrangements (FSAs); 

8) Group term life insurance (§ 79); 

9) Health Savings Accounts (HSA’s) (§ 223 and § 125(d)(2)(D); 

and 

10) Long-term and short-term disability coverage (§ 106).2

Additionally, an employer can offer coverage under a 401(k) cash 

or deferred arrangement under a cafeteria plan.3

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, 

§ 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

2) Availability of Benefits - the plan will not pass the nondiscrimination 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

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

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 § 125(e)(1) as a participant who is 

SBREP-219A with DISTILLER

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7 I.R.C. § 416(i)(1) (2006). 

8Prop. Reg. § 1.125-1, § 1.125-2, § 1.125-5, § 1.125-6 and § 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. § 401(c) (2006). 

10 I.R.C. § 129 (2006). 11 James Wooten, THE EMPLOYEE RETIREMENT INCOME SECURITY ACT OF 1974 - A POLITICAL

HISTORY, 31-32 (2004). 12 Revenue Act of 1942, § 127(a), Pub. L. No. 753, 56 Stat. 798, 825, codified as Internal Revenue Code of 1939, § 23(x). 13Daniel 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. 

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, § 125 defines a key employee, in reference to 

§ 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

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 

§ 125 cafeteria plans, but are still able to sponsor plans for their 

employees.8 This is unlike § 401(c), where self-employed individuals 

can participate in pension, profit-sharing and stock bonus plans 

along-side their employees.9 And in § 129, where these individuals 

can also participate in dependent care assistance programs.10

Legislative History 

Provisions excluding highly compensated individuals from taxsheltered 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

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 shareSBREP-219A with DISTILLER

20 

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)). 16Daniel 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, § 134(a), 92 Stat. 2763, 2783, codified as Internal 

Revenue Code of 1954, § 125. 20 Revenue Act of 1978, Pub. L. No 95-600, § 134(a), 92 Stat. 2763, 2783, codified as Internal 

Revenue Code of 1954, § 125. 21See 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). 23Tax Reform Act of 1984, Pub. L. No. 98-369, § 53, 98 Stat. 494, codified as Internal Revenue 

Code of 1954, § 125. 24Tax Reform Act of 1984, Pub. L. No. 98-369, § 53(b)(2), 98 Stat. 494, codified as Internal 

Revenue Code of 1954, § 125(b)(2). 

holder-officers as a ‘‘way to disguise [otherwise taxable] dividends.’’ 15

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 lowerpaid 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 § 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

But, during the time period between 1978 to 1983, Treasury did 

not issue any regulations regarding non-discrimination in § 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

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 

SBREP-219A with DISTILLER

21 

25See, 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). 26Prop. Reg. § 1.125-7, 72 Fed. Reg. 43938 (Aug. 6, 2007). 27Prop. Reg. § 1.125-7, 72 Fed. Reg. 43938 (Aug. 6, 2007) (emphasis added). 28Pub. L. No 111-148. 

provided to a key employee could quickly exceed the 25% threshold.25

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: 

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

Later, in 2010, as part of the Patient Protection and Affordable 

Care Act (the ‘‘PPACA’’ or the ‘‘ACA’’), Congress relaxed the nondiscrimination requirements for § 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. 

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. 

SBREP-219A with DISTILLER

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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: 

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1Frequently 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. 

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 outof-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 commonlaw 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. 

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 majorSBREP-219A with DISTILLER

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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). 

ity 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. 

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. 

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3Frequently 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 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. 

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 

SBREP-219A with DISTILLER

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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. § 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. § 79 (life insurance and accidental death), 26 U.S.C. §§ 105-106 (medical, dental, vision, 

short- and long-term disability), and possibly 26 U.S.C. § 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 

SBREP-219A with DISTILLER

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4 Child Care Costs in the United States, Economic Policy Institute, available at http:// 

www.epi.org/child-care-costs-in-the-united-states/. 5Market Survey of Long-Term Care Costs, MetLife (2012), available at https:// 

www.metlife.com/mmi/research/2012-market-survey-long-term-carecosts.html?WT.ac=PRO—Pro3—PopularContent—5-18491—T4297-MMmmi&oc—id=PRO—Pro3—PopularContent—5-18491—T4297-MM-mmi#keyfindings. 

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. 

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. § 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. 

SBREP-219A with DISTILLER

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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 

SBREP-219A with DISTILLER

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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?’’ 

SBREP-219A with DISTILLER

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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. 

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TESTIMONY 

OF 

NATIONAl ASSOCIATION OF INSURANCE AND FINANCIAL ADVISORS 

MATTHEW TASSEY, TREASURER 

HOUSE SMALL BUSINESS COMMITTEE 

SUBCOMMITTEE ON ECONOMIC GROWTH, TAX, AND CAPITAl ACCESS 

"Cafeteria Plans: A menu of Non-Options for Small Business Owners" 

March 16,2017 

Good morning Chairman Brat, Ranking Member Evans, and Members of the Subcommittee. My 

name is Matthew Tassey, and I am testifying today on behalf of the National Association of 

Insurance and Financial Advisors ("NAIFA") for whom I currently am serving as Treasurer. 

Thank you for giving us this opportunity to share our perspective on cafeteria plans. 

Founded in 1890 as The National Association of Life Underwriters (NALU), NAIF A is one of the 

nation's oldest and largest associations representing the interests of insurance professionals 

from every Congressional district in the United States. NAIFA's mission is to advocate for a 

positive legislative and regulatory environment, enhance business and professional skills, and 

promote the ethical conduct of its members. Most of our members work with small businesses 

and their owners on a wide variety of security and financial needs confronting the businesses, 

their owners, and employees. As a result, most NAIF A members routinely talk to their clients 

about cafeteria plans and the benefits they offer the business, the workers, and the owners. 

I am a principal of Scribner Insurance and Burwell & Burwell, an employee benefits broker in 

Portland, Maine. I work with small and some large employer groups in all aspects of benefit 

plans and design. 

On behalf of my colleagues at NAIFA and most importantly, on behalf of our small business 

owner dients, thank you for your interest in allowing them to participate in a cafeteria plan. 

Background 

A cafeteria plan is a separate written plan maintained by an employer for employees that meets 

the specific requirements of and regulations of Section 125 of the Internal Revenue Code, It 
32 

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allows eligible workers to choose from among a variety of qualified benefits, or instead receive 

taxable cash. Usually, if a worker chooses one or more of the benefits offered in the plan, the 

benefits are paid for by way of a pre-tax salary reduction amount. 

A qualified benefit is a benefit that does not defer compensation and is excludable from an 

employee's gross income. Qualified benefits include: 

Accident and health benefits (but not Archer medical savings accounts or long-term 

care insurance) 

• Adoption assistance 

Dependent care assistance 

Group-term life insurance coverage 

• Health savings accounts, including distributions to pay long-term care services 

Section 125 requires the plan to specifically describe all benefits, establish rules for eligibility 

and elections, and to be offered on a nondiscriminatory basis. To ensure compliance, the 

Internal Revenue Code sets forth testing requirements that must be satisfied. These testing 

requirements are in place to make certain that Cafeteria Plan benefits are available to all 

eligible employees under the same terms, and that the Plan does not favor highly compensated 

employees, officers, and owners. 

Premium Only Plan {POP) 

Employers may deduct employees' portion of the company-sponsored insurance premium 

directly from employees' paychecks before taxes are deducted. 

Flexible Spending Account {FSA} 

In an FSA, employees may set aside on a pre-tax basis a pre-established amount of money per 

plan year. Employees can use the funds in the FSA to pay for eligible medical, dependent care, 

or transportation expenses. 

Improve Cafeteria Plans by Making Pass-Through Business Owners Eligible to Participate, and 

Allowing Cafeteria Plans to Offer Qualified long-Term Care Insurance 

There are two elements of the cafeteria plan rules that could be substantially improved: first, 

under current law, owners of pass-through businesses-Subchapter S corporations, 

partnerships, LLCs, and sole proprietorships-may not participate in a cafeteria plan. This 

should be changed. Second, a security benefit of growing importance to America's workers, 

long-term care insurance, is not a permissible benefit in a cafeteria plan. This, too, should be 

corrected. 

NAIFA strongly encourages Congress to correct these two issues, by making pass-through 

business owners eligible to participate in a cafeteria plan and to allow inclusion of employersponsored qualified long-term care insurance in cafeteria plans. 

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Cafeteria Plan Benefits Outweigh Disadvantages 

Since their introduction in the early 1980's, cafeteria plans have become a popular method for 

employers to provide health and other benefits in a way that results in employee tailored 

benefits. 

Not every employee has the same security needs as their co-workers. A family with young 

children will value a cafeteria plan's dependent care benefit, while a single worker who has no 

children will find that benefit of no real value. Some workers get their health insurance through 

their spouse's plan, making their own employer's offer of health insurance less valuable. Some 

workers find the flexibility of an FSA valuable in meeting their projected health expenses that 

are not covered by insurance, while others would prefer a different benefit or taxable cash 

compensation. Cafeteria plans allow different workers to accommodate their unique situations 

in choosing the benefits that are most valuable to them. 

The uniform reimbursement aspect of section 12S allows an employee to be reimbursed for 

qualified medical expenses that exceed their contributions to date. This rule can put the 

employer at risk if an employee in a health FSA quits before contributing the full amount for 

which he has been reimbursed, and there is a modest employer cost to installing and 

maintaining a cafeteria plan. 

Under the "use it or lose it" rule, an employee must forfeit unused FSA contributions at the end 

of the plan year. However, with appropriate planning and good communication, the effect of 

any disadvantages can be greatly minimized. 

The advantages of establishing a cafeteria plan for both employers and employees significantly 

outweigh any perceived disadvantages. Employees can receive the benefits they want while at 

the same time helping to control benefit costs. 

Make Pass-Through Business Owners Eligible to Participate in Cafeteria Plans 

Small employers are often organized as pass-through businesses. The Small Business 

Administration 2016 profile indicates small businesses employed 56.8 million people or 48 

percent of the total U.S. workforce. 

While not all pass-through businesses are small, most are. And most employ workers. Business 

owners, or in the case of the Subchapter S business, its partners-shareholders ultimately pay 

the bill for the workers' salaries, and for all the employee benefits that their businesses offer. It 

is unfair, to say the least, that these business owners cannot participate in a benefits plan as 

valuable as the cafeteria plan. These business owners have unique security and benefits needs 

just like their employees. The discrimination rules contained in IRC Section 125 would prevent a 

pass-through business owner from designing a plan that primarily benefits him or herself. 

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Cafeteria plan rules require that at least 75 percent of the plan's benefits accrue to the plan 

sponsor's non-highly-compensated/non-key employees. 

lincolnville Telephone is a family owned company providing phone/internet coverage in midcoast Maine with 40 employees. There are five family members who are excluded from 

participating in the Section 125 program. They offer it anyway to provide this benefit to their 

employees and their families to help reduce the costs for themselves and their dependents. 

They also use the FSA opportunity to reduce out of pocket costs. 

RHR Smith & Co, a 20 person accounting/audit firm in Buxton, Maine does the same thing in 

spite of the three shareholders being excluded. 

The inability of the small business owner to participate in a cafeteria plan acts as a disincentive 

to design, implement, administer and pay for a cafeteria plan-which, according to the rules of 

section 12S, must be in writing and permanent in nature. Making small business owners eligible 

to participate in cafeteria plans would likely encourage more of my small business clients 

interested in making these flexible plans available to their workers. That, in turn, would 

increase the financial security of their employees and themselves. 

We insure about 60 smaller companies who do not participate because they are structured as 

partnerships Sub-S corporations, and they may only have part-time employees and are denied 

participation. As the "oldest state in the country" healthcare can often cost a family $1800-

$2200/monthly and these small business owners are unable to take advantage of this very 

important benefit. 

Make Long-Term Care Insurance a Permissible Cafeteria Plan Benefit 

Qualified long-term care insurance is, for tax purposes, treated as health insurance. Because it 

is also considered akin to deferred compensation, this increasingly valuable form of insurance is 

not permitted to be included in the menu of cafeteria plan offerings. 

With our aging population, the pressure on Medicaid, and an increasing sense of responsibility 

for planning for the expenses of "living too long," the need for long-term care insurance is 

acute and growing. The ability to provide for that need through the convenience of an 

employer-sponsored cafeteria plan would likely increase the number of people who protect 

themselves against the risk of expensive long-term care via qualified long-term care insurance. 

This would contribute to workers' peace of mind, and quality of work-life balance. It would ease 

some of the pressure on Medicaid and family resources as loved ones incur the long-term care 

expenses. And, qualified long-term care insurance is subject to protective rules, both on the 

quality of the policies and on the cost to taxpayers of making those policies available-as is the 

case for long-term care insurance purchased outside of a cafeteria plan. 

4jPage 
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Summary 

Cafeteria plans allow employers to offer flexible benefits to their workers, at a reasonable cost 

to both the workers and the employers. The flexibility of being able to let workers choose 

benefits best suited to their unique circumstances is often the most important reason for an 

employer to establish and maintain this type of benefits plan. 

It is unfair to pass-through business owners to exclude them from eligibility to participate in 

cafeteria plans. And, it may discourage these owners from offering-and paying for-cafeteria 

plan benefits to those who work for them. 

long-term care insurance is more like health insurance than like deferred compensation. It is a 

security product that should be permitted as a cafeteria plan option. 

Thank you again, Mr. Chairman and members of the Subcommittee, for this opportunity to 

provide you with NAlFA's views on this important topic. I'd be pleased to answer any questions 

you may have. 

SIPage 
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® 

CONGRESSWOMAN YVETTE D. CLARKE 

REPRESENTING NEW YORK'S gth CONGRESSIONAL DISTRICT 

Event Name: Small Business Committee on Economic Growth, Tax, and Capital 

Access Hearing on Cafeteria Plans 

Date: March 16,2017 

Time: 1 O:OOAM 

Location: RHOB 2360 

Assigned Staffer: Harry 

Host(s): Congresswoman Yvette D. Clarke 

.Additional materials: Hearing memo attached. 

Talking Points/Remarks 

• Thank you Mr., Chairman and a pleasant good morning to everyone. 

• We are here today to discuss the tax treatment of Section 125 cafeteria plans. 

• These plans provide employees at all levels of the corporate hierarchy with 

crucial tax benefits that make it easier to afford health insurance, 

prescription drug coverage, adoption assistance, and numerous other benefits 

that are crucial to quality of life. 

• Unfortunately, proposed regulations from the Treasury Department, 

combined with statutory ambiguity, make it hard for small business owners 

to participate in the benefits of these plans. 

• This places small business owners in a comparatively worse position than 

their big business counterparts for no clear reason. It also makes it less likely 

that they will sponsor cafeteria plans which leaves their employees worse 

off. 

• I am grateful to the Chairman and Ranking Member for highlighting this 

issue, since it is an important one on which I hope we can work together. 

• This hearing is particularly timely in light of the continuing discussion over 

tax reform. While there is much talk concerning reforming the way that we 
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tax corporations overseas, this hearing reminds us that ultimately the tax 

code impacts everyday people here at home. 

• It is my hope that we do not lose sight of this fact in the months ahead and 

that we continue to do everything in our power to ensure that small business 

owners receive the tax benefits that they deserve. 

• I look forward to learning more about this important issue and to working 

with my colleagues to help ensure that small business owners receive fair 

treatment in accessing tax benefits. 
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ON: Cafeteria Plans: A Menu of Non-Options for Small 

Business Owners 

TO: Subcommittee on Economic Growth, Tax, and Capital 

Access of the House Small Business Committee 

BY: U.S. Chamber of Commerce 

DATE: March 16, 2017 

1615 H Street NW I Washington, DC 120062 

econornic. 
39 

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. 

SBREP-219A with DISTILLER

40 

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). 

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41 

1The Chamber supported S. 555 - (110th Congress) the SIMPLE Cafeteria Plan Act of 2007 

and encourages Congress to move forward with similar legislation. 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. 

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

Congress Should Encourage Expansion of the Types of 

Benefits That Can be Provided in a Cafeteria Plan. Longterm 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 

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5Melissa 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. 

8Long-Term Care Insurance Premium Sample, available at http:// 

www.guidetolongtermcare.com/premiumsample.html. 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. 

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

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-yearold; 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. 

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. 

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 parSBREP-219A with DISTILLER

43 

ticipation by small business owners and their employees in cafeteria plans. Thank you for your consideration of this statement. 

Æ 

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