Can a Texas state university offer employees a section 125 cafeteria benefits plan?

Texas AG Opinion JM-543: University Cafeteria Plan

Plain-English summary

The chancellor of the University System of South Texas asked whether the university could set up a "cafeteria plan," the kind of employee benefit plan described in section 125 of the Internal Revenue Code that lets workers choose between cash and certain tax-free benefits. An earlier AG opinion (JM-143, 1984) had said a community college could do this under article 3.50-3 of the Insurance Code, but Congress amended section 125 in the Deficit Reduction Act of 1984, so the question had to be answered under the current version of the federal statute. Source: https://www.texasattorneygeneral.gov/sites/default/files/opinion-files/opinion/1986/jm0543.pdf

The AG concluded the university may establish such a plan. Under the amended section 125, a cafeteria plan must offer a choice between cash and statutory nontaxable benefits, and a temporary IRS regulation (26 C.F.R. section 1.125-2T) allows a plan to let employees purchase, with after-tax contributions, coverage under a group-term life insurance plan or an accident or health plan. Article 3.50-3 of the Insurance Code requires state universities to provide basic life, accident, and health coverage, authorizes a university's governing board to add optional insurance programs, and allows payroll deduction of optional-coverage premiums. Putting those together, the university has authority to offer employees the chance to buy optional life or health coverage with after-tax contributions, and that arrangement can qualify as a section 125 cafeteria plan if all the other federal requirements are satisfied. The AG stressed it was not approving any specific plan (none had been submitted), noted that section 1.125-2T was only a temporary regulation and that Congress was then overhauling the tax code, and said its earlier opinion JM-143 no longer described cafeteria plans as they now exist and should be disregarded. Source: https://www.texasattorneygeneral.gov/sites/default/files/opinion-files/opinion/1986/jm0543.pdf

Currency note

This opinion was issued in 1986. Subsequent statutory amendments, court decisions, or later AG opinions may have changed the analysis. Section 125 of the Internal Revenue Code and its regulations have been revised many times since 1986 (the opinion itself noted Congress was then rewriting the federal tax code), and article 3.50-3 of the Insurance Code has been recodified. Treat this page as historical context, not current legal advice. Verify current federal and state law before relying on any specific rule or citation mentioned here.

Common questions

Could a Texas state university set up a section 125 cafeteria plan for its employees?

Yes. The AG concluded the University System of South Texas had authority under article 3.50-3 of the Insurance Code to establish a plan letting employees buy optional group-term life or accident and health coverage with after-tax contributions, and that such a plan could qualify as a cafeteria plan under section 125 of the Internal Revenue Code if the other federal conditions were met. Source: https://www.texasattorneygeneral.gov/sites/default/files/opinion-files/opinion/1986/jm0543.pdf

What is a cafeteria plan under section 125?

As the AG described it under the amended statute, a cafeteria plan is a written plan that offers employees a choice between cash and certain statutory nontaxable benefits, and when the conditions are met the nontaxable benefits can be excluded from the employee's gross income even though they were received instead of cash. Source: https://www.texasattorneygeneral.gov/sites/default/files/opinion-files/opinion/1986/jm0543.pdf

Why did the AG say its earlier opinion should be disregarded?

Because the law had changed. The AG explained that the plan described in JM-143 (1984) let employees choose between taxable and nontaxable benefits, but after the Deficit Reduction Act of 1984 amended section 125 a cafeteria plan had to offer a choice between cash and certain nontaxable benefits. So JM-143 no longer described cafeteria plans as they existed under current law and should be disregarded. Source: https://www.texasattorneygeneral.gov/sites/default/files/opinion-files/opinion/1986/jm0543.pdf

Did the AG approve a specific plan?

No. The AG pointed out that no plan had been submitted, expressed no opinion on the details of any particular plan, and noted the governing regulation was only temporary. Any plan would still have to comply with the relevant code provisions and regulations. Source: https://www.texasattorneygeneral.gov/sites/default/files/opinion-files/opinion/1986/jm0543.pdf

Background and statutory framework

Section 125 of the Internal Revenue Code, as amended by the Deficit Reduction Act of 1984, defines a cafeteria plan as a written plan under which all participants are employees and participants may choose among two or more benefits consisting of cash and statutory nontaxable benefits; optional life insurance above $50,000, ordinarily includible in gross income, is treated as a nontaxable benefit when offered in a cafeteria plan. The IRS issued a temporary regulation, 26 C.F.R. section 1.125-2T, which taxpayers could rely on pending final rules; it allowed a plan to offer participants the chance to purchase, with after-tax employee contributions, coverage under a group-term life insurance plan (section 79) or an accident or health plan (section 105(e)), among others. Source: https://www.texasattorneygeneral.gov/sites/default/files/opinion-files/opinion/1986/jm0543.pdf

On the state side, article 3.50-3 of the Insurance Code requires state universities to provide basic life, accident, and health coverage to employees, with standards set by an administrative council, and provides that an employee is automatically covered by a basic plan unless he waives it or chooses optional coverage, with basic coverage potentially funded in part by a salary deduction. The statute also authorizes a university's governing board to provide additional or optional insurance programs it deems desirable (section 4(b)(4)(F)), and the administrative council's rule (19 T.A.C. section 25.34(c)) requires provision for payroll deduction of optional-coverage premiums. The AG combined these authorities to conclude the university could offer the after-tax optional-coverage purchase described in the temporary regulation. It noted it was not addressing group legal services or dependent care payments, cautioned that a deduction from an employee's state-funded compensation must be authorized by law (V.T.C.S. article 6813e), and disregarded JM-143 to the extent it described cafeteria plans under the pre-amendment law. Source: https://www.texasattorneygeneral.gov/sites/default/files/opinion-files/opinion/1986/jm0543.pdf

Citations and references

The opinion cited the following authorities. Source: https://www.texasattorneygeneral.gov/sites/default/files/opinion-files/opinion/1986/jm0543.pdf

Statutes and regulations:

• I.R.C. § 125; § 79 (26 U.S.C. §§ 125, 79)
• 26 C.F.R. § 1.125-2T
• Deficit Reduction Act of 1984, Pub. L. No. 98-369
• Insurance Code art. 3.50-3, §§ 2(a), 2(b), 4(b)(4)(F), 11, 12, 17
• 19 T.A.C. § 25.34(c)
• V.T.C.S. art. 6813e (payroll deductions)

Attorney General opinions cited:

• Attorney General Opinions JM-143 (1984); MW-215 (1980)

Source

• Landing page: https://www.texasattorneygeneral.gov/opinions/jim-mattox/jm-0543
• Original PDF: https://www.texasattorneygeneral.gov/sites/default/files/opinion-files/opinion/1986/jm0543.pdf

Original opinion text

Best-effort transcription from a scanned PDF. Minor errors may remain; the linked PDF is authoritative.

September 12, 1986

Mr. Lawrence K. Pettit
Chancellor
University System of South Texas
P. O. Box 1238
Kingsville, Texas 78363

Opinion No. JM-543

Re: Whether a state university may establish a "cafeteria plan" under section 125 of the Internal Revenue Code

Dear Mr. Pettit:

You ask whether the University System of South Texas may establish an employee benefit plan of the type described as a "cafeteria plan" in section 125 of the Internal Revenue Code. Attorney General Opinion JM-143 (1984) determined that a community college had authority under article 3.50-3 of the Insurance Code to establish a "cafeteria plan" consisting of various taxable and nontaxable fringe benefits in the area of life, accident and health, and disability insurance. Since state universities are also authorized to contract for insurance coverage under article 3.50-3 of the Insurance Code, see Attorney General Opinion MW-215 (1980), you believe that the reasoning and result of Attorney General Opinion JM-143 will apply to the University System of South Texas. Section 125 of the Internal Revenue Code (I.R.C.) has, however, been amended since Attorney General Opinion JM-143 was issued. See Deficit Reduction Act of 1984, Pub. L. No. 98-369, § 531(b)(1), (4)(A), 98 Stat. 881 (1984). Your question must be addressed in relation to the present version of section 125.

A "cafeteria plan" as defined by section 125 of the Internal Revenue Code is an employee benefit plan which offers employees a choice between cash and nontaxable fringe benefits. I.R.C. § 125(d); 26 C.F.R. § 1.125-2T. If the statutory conditions are met, the nontaxable benefits may be excluded from gross income even though the employee has received them in lieu of cash compensation. Id. See also H.R. Rep. No. 432, pt. II, 98th Cong., 2d Sess., 1608-09, reprinted in 1984 U.S. Code Cong. & Ad. News 698, 1232-33. Section 125 of the code states in part:

(a) In general. Except as provided in subsection (b), no amount shall be included in the gross income of a participant in a cafeteria plan solely because, under the plan, the participant may choose among the benefits of the plan.

(b) [Exception where plan discriminates in favor of highly compensated individuals and key employees].

(c) [Discrimination further defined].

(d) Cafeteria plan defined. For purposes of this section --

(1) In general. The term 'cafeteria plan' means a written plan under which --

(A) all participants are employees, and

(B) the participants may choose among 2 or more benefits consisting of cash and statutory nontaxable benefits.

(2) [Deferred compensation plans excluded].

(e) [Highly compensated participant and individual defined].

(f) Statutory nontaxable benefits defined. For purposes of this section, the term 'statutory nontaxable benefit' means any benefit which, with the application of subsection (a) is not includible in the gross income of the employee by reason of an express provision of this chapter [26 U.S.C.S. § 1 et seq.] (other than section 117, 124, 127, or 132 [26 U.S.C.S. § 117, 124, 127, or 132]). Such term includes any group term life insurance which is includible in gross income only because it exceeds the dollar limitation of section 79 [26 U.S.C.S. § 79].

(h) [reporting and recordkeeping requirements].

(i) [regulations]. (Emphasis added).

I.R.C. § 125. Amendments of particular significance to your question are underlined.

As the "cafeteria plan" is now defined, it must offer employees a choice between cash compensation and certain nontaxable fringe benefits. I.R.C. § 125(d)(1); 26 C.F.R. § 1.125-2T; H.R. Rep. No. 432, pt. II, 98th Cong., 2d Sess., 1608-09, reprinted in 1984 U.S. Code Cong. & Ad. News 698, 1232-33; H.R. Conf. Rep. No. 861, 98th Cong., 2d Sess., 1173-74, reprinted in 1984 U.S. Code Cong. & Ad. News 1445, 1861-62. Moreover, optional insurance coverage in an amount in excess of $50,000, usually includible in gross income, is treated as a nontaxable benefit when offered in a cafeteria plan. I.R.C. § 125(f); see I.R.C. § 79.

The Internal Revenue Service has issued a temporary regulation on cafeteria plans. According to information published by IRS in the Federal Register, taxpayers may rely on this temporary regulation pending the issuance of final regulations, but it is not intended to address all issues raised by the amendments to section 125 of the Internal Revenue Code. 51 Fed. Reg. 4318 (1986). The temporary regulation on cafeteria plans states in part:

Generally, for cafeteria plan years beginning on or after January 1, 1985, a cafeteria plan is a written plan under which participants may choose among two or more benefits consisting of cash and certain other permissible benefits. . . . a cafeteria plan may offer participants the opportunity to purchase, with after-tax employee contributions, coverage under a group-term life insurance plan (section 79), coverage under an accident or health plan (section 105(e)), coverage under a qualified group legal services plan (section 120), or coverage under a dependent care assistance program (section 129). (Emphasis added).

The cafeteria plan described in Attorney General Opinion JM-143 (1984) allowed employees to choose between taxable and nontaxable benefits. Under present law, the cafeteria plan must offer the employee a choice between cash and certain nontaxable benefits. Under the quoted regulations, an employee's participation in a nontaxable benefit offered in a cafeteria plan may be funded by a salary deduction. 26 C.F.R. § 1.125-2T; see 10 Thurgood Marshall L. Rev. 522, 532 (1985).

Article 3.50-3 of the Insurance Code requires state universities to provide basic life, accident, and health insurance coverage to employees. Ins. Code art. 3.50-3, §§ 2(a), 2(b), 11. Standards for basic coverage are developed by an administrative council established under section 4 of the statute. Section 11 of article 3.50-3 provides that each active full-time employee shall be automatically protected by a basic plan of insurance coverage, unless he waives basic coverage or chooses optional coverage. Section 11 makes the following provision for premium payments:

If the cost of an active employee's basic coverage exceeds the amount appropriated by the legislature for an employee, the institution must provide optional coverage at no cost to the employee. If the employee chooses basic coverage rather than optional coverage, the institution may deduct from the monthly compensation of the employee up to one-half the amount that exceeds the state's contribution for an employee, and the institution shall pay the difference. . . . (Emphasis added).

Thus, it is possible that basic coverage may be partially funded by a deduction from the employee's salary. See also Ins. Code art. 3.50-3, §§ 12, 17.

Article 3.50-3 of the Insurance Code also authorizes the governing board of a state university to "provide such additional or optional insurance programs and coverages as it deems desirable for its employees." Ins. Code art. 3.50-3, § 4(b)(4)(F). The Administrative Council has issued the following regulation: "Provisions shall be made for the payroll deduction for premiums of the optional coverage." 19 T.A.C. § 25.34(c).

The governing body of a university may use its authority under section 4(b)(4)(F) of article 3.50-3 and rule 19 T.A.C. section 25.34(c) to offer employees

the opportunity to purchase, with after-tax employee contributions, coverage under a group-term life insurance plan (section 79), [or] coverage under an accident or health plan (section 105(e)). . . .

26 C.F.R. § 1.125-2T.

You have not inquired about authority to include group legal services or dependent care assistant payments in a cafeteria plan. We do not address this question; however, we note that the governing body of a university may not make a deduction from the compensation of an employee paid from state funds unless the deduction is authorized by law. See V.T.C.S. art. 6813e.

You have not submitted a plan to us and we express no opinion as to the details of such a plan. A cafeteria plan must comply with the relevant code provisions and regulations. We also point out that 26 C.F.R. section 1.125-2T is a temporary regulation and that Congress is at present engaged in a major revision of the Internal Revenue Code. See U.S. Code Cong. & Ad. News, August 1986. Attorney General Opinion JM-143 (1984) does not describe cafeteria plans as limited by present law and should be disregarded.

SUMMARY

The University System of South Texas has authority under article 3.50-3 of the Insurance Code to establish an employee benefit plan whereby employees are offered an opportunity to purchase with after-tax employee contributions coverage under a group-term life insurance plan or an accident or health plan. This plan may qualify as a "cafeteria plan" under section 125 of the Insurance Code if all other conditions imposed by federal law and regulation are implemented. Attorney General Opinion JM-143 (1984) does not describe "cafeteria plans" as they now exist and should be disregarded.

Very truly yours,

Jim Mattox
Attorney General of Texas

JACK HIGHTOWER
First Assistant Attorney General

MARY KELLER
Executive Assistant Attorney General

RICK GILPIN
Chairman, Opinion Committee

Prepared by Susan L. Garrison
Assistant Attorney General