Category: Compensation and
Employee Benefits Copyright 1998, The Tax Resource Group. All rights reserved. Telephone 800-578-3498. Internet: www.taxresourcegroup.com You have inquired about the availability of a tax-qualified dependent care assistance plan for a C corporation with only two employees, both of whom are 50% shareholders of the corporation. The plan would be put in place either separately or as part of a cafeteria plan. Both dependent care assistance plans and cafeteria plans must meet various anti-discrimination requirements. You feel that because the corporation has only two employees, both of whom would be covered under the plan, it is not conceptually possible for the plan to be discriminatory. I agree with that argument in theory, but as we discussed, there is another rule that causes a problem. Dependent care assistance plans are controlled by Internal Revenue Code (IRC) Section 129, and cafeteria plans are controlled by IRC Section 125. Both provisions contain rules to the effect that the tax-qualified benefits offered under the applicable plan are not available on a tax-free basis to certain groups (i.e., key employees or more-than 5% owners) if the plan discriminates in favor of one or more of those groups. These are the rules you have mentioned. I am concerned about what I will hereinafter refer to as the 25% rule. For dependent care assistance plans, Section 129(d)(4) provides as follows. Not more than 25 percent of the amounts paid or incurred by the employer for dependent care assistance during the year may be provided for the class of individuals who are shareholders or owners (or their spouses or dependents), each of whom (on any day of the year) owns more than 5 percent of the stock or of the capital or profits interest in the employer. Dependent care assistance plans were enacted by the Economic Recovery Tax Act of 1981. The rule set forth above was contained in the statute as originally enacted. Congressional committee reports surrounding enactment of any tax law often provide guidance as to the thinking of those members of congress involved in drafting and passing a given law. If the meaning of a law or a particular portion of a law is not clear, the committee reports can be used to resolve doubts as to interpretation. In this case, the committee reports are silent as to the 25% rule set forth above. For cafeteria plans, Section 125(b)(2) provides as follows. In the case of a key employee (within the meaning of section 416(i)(1)), subsection (a) shall not apply to any benefit attributable to a plan for which the statutory nontaxable benefits provided to key employees exceed 25 percent of the aggregate of such benefits provided for all employees under the plan. For purposes of the preceding sentence, statutory nontaxable benefits shall be determined without regard to the last sentence of subsection (f). The general cafeteria plan rules were enacted in 1978 without the 25% rule set forth above. The 25% rule was added by the 1984 Tax Act. The committee reports surrounding this change simply mention the change without any clarification or further commentary. There are no regulations under Section 129, and the regulations under Section 125 do not address the 25% rule. There are no court cases or IRS rulings or pronouncements of any type that interpret, modify, or mitigate the 25% rule. In my opinion, the 25% rule is not really a provision aimed at discrimination; rather the rule deals with concentration of benefits, a different concept entirely. Discrimination rules deal with schemes whereby an employer might exclude rank-in- file employees from benefits made available to some other favored group, or in the alternative, schemes whereby more desirable benefits are provided to some favored group than are available to rank-in-file employees. The 25% rule is clearly incremental to the anti-discrimination rules. In effect, the 25% rule says no matter how even-handedly plan benefits are made available to employees, no more than 25% of all benefits provided can go to key employees or more-than-5% owners. In my experience, tax rules don't get any clearer than this. The words of the statue are unequivocal. That alone is dispositive of the question. Add to that the absolute lack of any dissenting voice anywhere in the tax literature, and we end up with one of the rare occasions in which there is a 100% clear answer to a given question: a corporation with only two employees, which employees are equal owners of all the stock of the corporation, cannot provide tax qualified dependent care assistance. |
