Cafeteria Plans and Constructive Receipt

You may be forcing your employees to paying unnecessary taxes without even knowing. Here's how to avoid this common mistake.

Many employers offer a cash payment to employees who waive health insurance coverage. These cash payments are always taxable to employees who waive health insurance coverage, but did you know employees who elect the health insurance coverage may be subject to paying taxes on the cash payment that they didn’t receive?

Wait! What?

The Internal Revenue Service (IRS) has a term they use called “constructive receipt.” In simple terms, constructive receipt means a person has control over money that is not yet in their possession. As an example, think about an employee who receives their final paycheck for the year on December 31, 2018, but the employee doesn’t cash the check until January 10, 2019. The IRS will consider the employee to have been in constructive receipt of this money in 2018, and subject to income taxes for 2018, even though the employee didn’t physically have the money until 2019.

Constructive receipt also needs to be taken into consideration when an employer provides a cash payment to employees who waive health insurance coverage. Employees who are eligible for the health insurance plan have control over whether they receive a cash payment. That control exists because they have the option to waive coverage under the health insurance plan in return for a cash payment. This is a form of constructive receipt. 

This means an employee may actually elect health insurance coverage and have to pay taxes on the money they could’ve received had they waived coverage……unless the employer takes the appropriate steps and makes the cash payment available through a Cafeteria Plan. 

First, let’s illustrate this the wrong way and assume an employer offers employees $1,000 in taxable compensation if they waive health insurance coverage. Employees who waive coverage will receive an additional $1,000 in compensation. This compensation should be treated like a cash bonus, subject to income and employment taxes. Employees who enroll in coverage will be considered to have constructively received $1,000, even though they didn’t receive any additional compensation. Employers will need to apply the appropriate wage-withholding and employment taxes to money the employee never received due to constructive receipt.  


But there is some good news. As long as an employer has a Cafeteria Plan in place which allows for the choice between health insurance and a cash payment, then constructive receipt will not apply to those employees who enroll in health insurance coverage. In other words, the employees who elect health insurance coverage can do so tax-free. The bottom line is to make sure the Cafeteria Plan document addresses this information so adverse tax consequences can be avoided. 

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