Richard Cauchi, Program Director, NCSL Health Program. 

About 3.7 million employers in the United States offer private or commercial health insurance to about 87 percent of the private-sector workforce - the single largest category of health coverage.[1] Yet at the same time, a 2008 report reveals that 43.7 percent of private sector establishments do not offer health insurance. The dramatic difference in these numbers mostly reflects the struggle of small and modest-sized employers to offer health coverage in the face of policies that now average about $4,700 for an individual and $12,680 annually for a family.[2]

In the past three years, several states are experimenting with a new use for an old idea, aimed at lowering costs for both employees and their employers. "Section 125 cafeteria plans" were created by a 1978 federal law which amended the Internal Revenue Code.  Designed as an optional feature for employers, cafeteria plans allow employees to pay for a variety of health care expenses without paying any federal tax on those charges. The result can be a savings of between 25% and 40% of every dollar the employee contributes to his or her plan.  The employer also realizes savings on FICA withholding tax for each participating employee, typically around $160 per year.  It costs about $100 per year per employee to create and administer a health-only cafeteria plan and several national companies compete for this business.

HOW IT WORKS (Sample Employee Notice) A "Cafeteria Plan" is a benefit provided by your employer which allows you to contribute a certain amount of your gross income to a designated account before taxes are calculated. These accounts are for insurance premiums, and medical (or dependent care) expenses not covered by your insurance, from which you can be reimbursed throughout the plan year or claim period as you incur the expenses. A cafeteria plan allows you to reduce your gross income, thereby reducing the amount you pay in Federal, Social Security, and some State taxes - a savings of between 25% and 40% of every dollar you contribute to the plan.

WEB FEATURES Cafeteria Plan State Laws Cafeteria Plan Legislation Federal laws

Many employers sponsor and offer such cafeteria plans as an additional benefit to workers, often combined with a direct employer contribution to a group health insurance plan, although not all are structured to allow premium payments.  The Segal Company concludes that while "most employers with health insurance already provide premium-only cafeteria plans for eligible employees," up to 10 percent of employers do not.  Again, in most cases it is smaller employers who do not provide these plans.   

As of mid-2008, at least 12 states had adopted a cafeteria plan approach into state-based health reforms, with a dual goal of keeping coverage available and affordable while expanding the numbers using commercial health insurance.

FEDERAL LAW

The federal law authorizing Cafeteria plans should be cited as 26 U.S. Code §125 [text online].  The Internal Revenue Service (IRS), Treasury promulgated Final Regulations in 2000, affecting Section 125 Plans, which are online as 26 C.F.R. Part 1 [TD 8878]; this IRS version includes a practical smmary, a chronology and contacts at IRS. 

ERISA: compatible or conflicting?

For states concerned about federal preemption of state law, cafeteria plans may be one of the safer approaches. The federal law requirements are well known and have even become slightly more flexible.  One ERISA expert, Patricia Butlerauthored a report published July 2008 describing it as follows: "Because Section 125 plans are "group health plans" under the Internal Revenue Code, it appears they are subject to both employer notice provisions under COBRA and employers and insurer nondiscrimination and benmefit design requirements under HIPAA.  But because the definition of employer group health coverage is different under ERISA than under federal tax code, as long as employers do not endorse or promote specific individually purchased health insurance policies, these policies should not be subject to ERISA.  Nor should a state requirement that employers offer Section 125 plans be preempted by ERISA.  However, states still cannot regulate "self-insured" health plans sponsored by many large employers.  Drafters need to recognize that care is needed to avoid a challenge to any broader law. 

For a complete and up-to-the-minute analysis of legal and practical issues, read "Legal Issues in State Requirements that Employers Offer Cafeteria (Section 125) Plans" by Patricia Butler, JD, Dr.PH in conjunction with the Institute for Health Policy Solutions.  Published by the California HealthCare Foundation, 10/6/08 [27 pages PDF]

• "Can Cafeteria Plans Expand Health Insurance Coverage?" - NCSL LegisBrief - October 2008 [free to members]  
  

There are considerable differences among the laws and plans:

STATE	LAW; DESCRIPTION	Required & Optional Features
Connecticut	On July 10, 2007 Connecticut enacted legislation (SB 1484) mandating cafeteria plans. The Connecticut law requires any employer providing health insurance benefits paid partly through payroll deductions to offer a cafeteria plan, effective October 1, 2007. To simplify employer paperwork, there are no filing requirements under this mandate. "Any employer that provides health insurance benefits to its employees for which any portion of the premiums are deducted from the employees' pay shall offer such employees the opportunity to have such portion excluded from their gross income for state or federal income tax purposes, except as required under Section 125 of the Internal Revenue Code of 1986..."   (Public Act 185, July 2007, now Conn. Gen. Stat. Section 38a-1041(f) ).	Required for some employers w/ health insurance
Florida	S. 2534 by Sen. Peaden, signed into law by governor on 5/21/08.  Creates the Cover Florida Health Care Access Program, which requires that employers who (voluntarily) choose to participate in the Access Program enroll by complying with the procedures which must include, "compliance with federal tax requirements for the establishment of a cafeteria plan, pursuant to section 125, including designation of the employer's plan as a premium payment plan, FSA [Flexible Savings Account] or both."  Also revises the eligibility requirements for participation in the Medikids program or the Fla. Healthy Kids program. (Fla. Stat §408.910(4)(c) ).	Optional for employers
Indiana	Effective Jan. 2008.  Created a tax credit to encourage employers to establish a fully insured health plan in combination with a 125 plan.  The state will provide the lesser of $50 per employee or $2,500 for 2 years if the employer offers such a plan. Applies to all Indiana firms that do not have a Section 125 plan. (Mathematica Fact Sheet 7/18/08.)	Optional for employers
Iowa	HF 2539, [Sec. 37] was signed into law May 13, 2008.  It requires the Commissioner of Insurance to  "assist employers with twenty-five or fewer employees with (voluntarily) implementing and administering" Section 125 plans including medical expense reimbursement accounts; also requires cafeteria plan features on the division's internet site.  (Iowa Code §505.31  - Reimbursement Accounts.)	Optional for employers
Kansas	Senate Bill 81, passed both Houses and signed into law by the governor 6/9/08, will require all insurers to offer premium-only Cafeteria Plans, while language stating that employers "shall" offer plans was amended to "may offer."  Effective date was July 1, 2008. > In 2007 S 357 established the Small employer cafeteria plan development program fund  for FY2008, and appropriated $150,000. (Signed as Chapter No. 2008-164; also see Chapter No. 2007-201, 7/13/07)	Optional for employers Required for insurers
Maryland	Senate Bill 6, signed November 2007, created the Working Families and Small Business Health Coverage Act. This is a voluntary plan with a specialized scope - offering subsidies to the smallest businesses, with one to nine employees. Those that join must offer a cafeteria plan.  Employers are under no obligation to apply for or participate in the small business subsidies and any employer with ten or more employees is ineligible. Effective Sept. 2008.	Optional for employers w/ 1-9 employees.
Massachusetts	(Chapter 58 of the Acts of 2006, section 48) Massachusetts in 2006 became the first state to require that all employers with 11 or more workers offer at least a "premium only" cafeteria plan. That requirement took effect on July 1, 2007 and is "one of the primary employer responsibilities" within a larger near-universal health plan, also requiring at least $295 annually in employer payments toward health costs and an individual mandate for residents to enroll in an insurance plan.  The law also includes state subsidized coverage and Medicaid expansions. [3]  (Mass. Gen. Laws ch. 151F, §2) Article:  "How Have Employers Responded To Health Reform In Massachusetts? Employees' Views At The End Of One Year."  Health Affairs, online 10/28/08. [8 pages PDF]	Required for employers w/ 11+ employees; also employer $ contribution
Minnesota	(SF 3780, signed into law 5/29/08 as Chapter 358, section 10) Effective July 2009.  Requires all employers with more than 10 employees who do not offer health insurance to establish a Section 125 plan.  It does not require employers to offer insurance coverage or contribute to it.  Includes an "opt out" provision. (Mathematica Fact Sheet 7/18/08.)  (Cite as: Minn. Stat. §62U.07)	Required for employers w/ 11+ employees
Missouri	(HB 818, June 2007) enacted legislation mandating cafeteria plans. The law applies to all employers with insured plans, effective Jan. 1, 2008. Self-insured plans are exempted. In both Connecticut and Missouri it is a pre-requisite that the employer have a health plan in place prior to being required to set up cafeteria plans.[4]  Both the Missouri and Connecticut laws require that employers establish cafeteria plans only if employees pay any part of premiums. Thus, if the employer pays the full cost of the insurance, the employer is not required to set up a cafeteria plan.	Required for employers  w/ insured plans
Rhode Island	(Senate Bill 448, now R.I Gen. Laws §27-70-1 through 3) signed in July 2007, became the first state to base a health insurance reform plan primarily on required use of Section 125 cafeteria plans (for employers with 25 or more workers.) Unlike Massachusetts, the RI law makes clear that employers do not have to "pay for or otherwise contribute to, the cost of any health insurance purchased through the cafeteria plan."   The law took effect "upon pasage," but is set for implementation July 1, 2009. Rhode Island's Senator Rhoda Perry, a lead sponsor, said, “This is not a huge expense for employers, but it could save their employees a significant amount of money. For some, that savings might be the difference between going uninsured and having some health care coverage.  And that small investment by the employer is probably going to save the employer money in the end, since healthy employees are more productive.”	Required for employers w/ 25+ employees
Tennessee	(S 333 & H 3360 of 2007) These laws require that "any employer who has implemented a cafeteria plan (pursuant to this section) shall arrange for its employees' health insurance premiums and dental insurance premiums to be automatically paid through the cafeteria plan beginning January 1, 2008."  (Signed into law as Chapter 184, 5/18/2007; and Chapter 674 4/1/2008)	Optional for employers
Washington	(Senate Bill 5930, 2007 law) enacted a voluntary Health Insurance Partnership for small business employers in which all participating employers are required to offer "125 plans." The state-run partnership in turn is required to "provide Cafeteria Plan technical assistance" to small employers, defined as those with one to 50 employees.  Larger firms are not affected.	Optional for employers

Other uses and references to Cafeteria Plans

Maine

Maine's comprehensive health reform, Dirigo Health, included the following authorization for the state program, although it did not require employers to use Section 125 accounts:  "Dirigo Health may administer or contract to administer Section 125 plans for employers and employees participating in Dirigo Health, including medical expense reimbursement accounts and dependent care reimbursement accounts." (2005 law, Chapter 400, Pt. C, §8 (AMD).)

Optional for agency and employers

Beyond these 13 states, at least 10 others have considered Cafeteria Plans as stand-alone bills or as a part of broader reform. Three widely publicized California reforms requiring Cafeteria Plans passed both chambers but did not become law.  (See separate bill list below)

EXAMPLE OF STATE-AUTHORIZED "Section 125 Plan" SAVINGS: (calculated by Massachusetts, 2007)

An employee who pays his/her health care coverage premiums on a pre-tax basis realizes a savings on state income, federal income and federal FICA taxes. This tax savings could amount to as much as 40% of the cost of health care coverage. The employer also realizes FICA withholding tax savings for each participating employee.

The example below illustrates the annual tax savings realized by an employee in Massachusetts with adjusted gross income of $50,000 who participates in his/her employer’s plan.  In this example, the employee achieves annual tax savings of $796 and his/her employer saves $161 in annual FICA taxes.:

Financial feature	w/o Plan	with Plan
Adjusted Gross Income	$50,000	$50,000
Annual Pre-tax Health Care Coverage Contribution	$0	$ 2,100
Taxable Income	$50,000	$47,900
Estimated Taxes	$12,676	$11,880
Annual After-Tax Health Care Coverage Contribution	$ 2,100	$0
Net Take Home Pay	$ 35,224	$36,020

2007-08 Bills mentioning Section 125 Cafeteria Plans
The following measures are excerpted from a 50-state search conducted December, updated August 2008, It may not be exhaustive for 2008 sessions.  Enacted laws are listed in the main report and generally are not repeated below.

State	Description; Status
AK S 160	Mandatory Universal Health Care plan, would require employers to participate in the Alaska health care program with payrolls of $1,000,000 or greater, the employer shall pay two percent of the gross payroll. An employer that establishes a cafeteria plan that offers employees the option to elect health care insurance coverage that meets or exceeds essential health care services is not subject to the payment requirements. (Did not pass by end of '08 session)
CA	Comprehensive health care reform and coverage expansion.  Included requirements that employers with varied numbers of workers sponsor and offer a premium cafeteria plan; employers also were required to contribute at least $395 annually toward the cost of health insurance premiums. CA AB 1072,  CA SB 820, CA AB 8  Would require every employer in the state to "adopt and retain a cafeteria plan (passed by Assembly and Senate; vetoed 10/12/07),  CA SB 23 a, CA AB 8 a , CA AB 2 a, CA AB 1 a (passed Assembly; did not pass Senate 1/18/08),
CA	AB 2 a (Speaker Nunez) : would, beginning January 1, 2010, require an employer, as defined, of 2 or more full-time equivalent employees in the state to adopt and maintain a cafeteria plan to allow employees to pay premiums for health care coverage to the extent amounts for that coverage are excludable from the gross income of the employee, as specified. The bill would require an employer who fails to establish or maintain a cafeteria plan to pay a penalty of $100 or $500 per employee, as specified. (Did not pass Assembly 11/17/07)
CO	Colorado (Blue Ribbon Commission for Health Care Reform) Final "5th Plan" released 1/31/08 includes "Require Colorado employers to establish at least a Section 125 premium-only plan that allows employees to purchase health insurance with pre-tax dollars.  (Recommendation 17a)   This recommendation was endorsed by the Commission’s Business Advisory Task Force.44 For employees with access to employer coverage, the ability to purchase coverage on a pre-tax basis can reduce the cost of coverage, the amount depending on the employee’s tax rate. The Lewin Group further estimates that Coloradans would save $372.9 million on their federal taxes through the use of 125 plans. Employers also could have the option to extend this pre-tax benefit to employees who are not eligible for the group plan but have established a “voluntary” individual plan with the Connector." [Final Report]
GA	GA S 28, GA S 150 The employer would agree to also sponsor a 'cafeteria plan'
IL	S 5 - No later than January 1, 2009, each employer with more than 10 employees shall adopt and maintain a cafeteria plan that satisfies 26 U.S.C. 125. (held in committee 12/3/07)
IA	(Commission on  Affordable Health Care Plans for Small Businesses and Families) **Dec. 2007.  Would require use of 125 Cafeteria plans - not yet filed as bill. 1/31/08 SSB 3140  -- Creates the Iowa Health  Care Coverage Exchange and Board, including "Studying the ramifications of requiring each employer with more than ten employees in this state to adopt and maintain a cafeteria plan"  (Did not pass Senate 3/11/08)
KS	(Health Reform Recommendations) The final report. Nov. 2007, included five options, three of which included cafeteria designs --: (2) voluntary individual and small market reform "access to Section 125 to open up tax benefits for offering insurance to more companies"; (3) a mandatory reform with access to cafeteria plans"; and (#5) Sequential Option is a three-part health insurance reform option with both voluntary and mandatory components, requiring "all employers provide access to Section 125 plans." KS S 540 - Kansas small business health policy committee may provide grants to small employers for the purpose of establishing a cafeteria plan authorized IRS Section 125.  (held in Committee, did not pass) KS H 2591 In order to encourage and to expand the use of cafeteria plans authorized by 26 U.S.C. 125, by small employers, there is hereby established the small employer cafeteria plan development program. (Did not pass, 3/22/07) KS S 81 - An insurer shall provide, in conjunction with a group health benefit plan, the option of establishing a premium only cafeteria plan as permitted under federal law, 26 U.S.C. section 125. An employer that provides health insurance coverage for which any portion of the premium is payable by an employee  shall may  also offer a premium only cafeteria plan as permitted Section 125.  There is hereby established in the state treasury the small employer cafeteria plan development program fund. The Kansas health policy authority  shall administer such fund and expenditures  from the small employer cafeteria plan development program fund for the purpose of providing grants in accordance with this section. All expenditures from the small employer cafeteria plan development program fund.  The cafeteria plan may offer the option of paying all or any portion of the health insurance premium or the option of receiving health insurance coverage through a high deductible health plan and the establishment of a health savings account. (passed Senate & House 4/08; Signed by Governor 6/9/08) Chapter No. 2008-164 S 357 - Appropriates for Small employer cafeteria plan development program fund  for the fiscal year ending June 30, 2008, $150,000. (Signed as Chapter No. 2007-201, 7/13/07)
MA	MA H 3936 of 2007.  Any employer with the equivalent total of five full-time employees must offer a cafeteria plan.  (Did not pass by end of session 2008)
MN	MN S 2171, SF 3099 establishing the Minnesota Health Insurance Exchange; requiring Section 125 Plans (passed & vetoed 5/8/07) , MN H 1729 (Did not pass) Effective January 1, 2009, all employers with 11 or more current employees shall establish a Section 125 Plan to allow their employees to purchase individual market health plan coverage with pretax dollars; MN H 1873 (Did not pass House 5/21/07),
NJ	NJ A 3452, NJ S 2202 requires all nongovernmental employers with 11 or more employees that provide their employees with health care coverage to also provide the employees with a cafeteria plan. (In comm. 2/28/08) NJ A 3766 Creates the State Health Insurance Exchange Act; providing employers with information about establishing and maintaining cafeteria plans NJ S 1147  Only for community colleges, requires establishment of cafeteria plans and collective negotiation of waiver terms prior to offering employees incentive to waive health care benefits.
NM	(Governor)  If an employer with 6+ employees has been doing business in NM for at least 3 years must offer this option whether or not they contribute to coverage plan.   **Dec. 2007
OK

Sources: NCSL legislative research; [password only] cafeteria plan search powered by StateNet.

"Legal Issues in State Requirements that Employers Offer Cafeteria (Section 125) Plans" by Patricia Butler, JD, Dr.PH in conjunction with the Institute for Health Policy Solutions.  Published by California HealthCare Foundation, 10/6/08 [27 pages PDF]