QUESTION: I’ve been asked whether members of our company’s board of directors can participate in our cafeteria plan. Can we allow this?
ANSWER: Generally, board members may not participate in your cafeteria plan because participation must be limited to employees. Therefore, members of your company’s board of directors who are not employees of the company (“outside directors”) cannot participate in your company’s cafeteria plan. This is the case whether or not the outside directors receive fees for their services as board members. The 2007 proposed cafeteria plan regulations expressly provide that the term “employee” does not include a self-employed individual and cite as an example a director serving on a corporation’s board of directors who does not otherwise provide services to the corporation as an employee.
Under a special rule for certain “dual status” individuals, an individual who is an employee of an employer and also provides services to that employer as a director (e.g., an individual who is both an employee and a director of a C corporation) is eligible to participate in the employer’s cafeteria plan, although solely in his or her capacity as an employee. For example, assume that one of your company’s employees also serves on the company’s board of directors. Her annual compensation as an employee of your company is $60,000; she also receives $4,000 in directors’ fees each year. She can participate in your company’s cafeteria plan in her capacity as an employee and can elect to make salary reductions from her employee compensation for benefits under the plan. However, she cannot elect to reduce her directors’ fees for benefits under the plan.
If your company is an S corporation, the dual-status rule will not apply to any employee-directors who are also more-than-2% shareholders. (More-than-2% shareholders in an S corporation are expressly excluded from cafeteria plan participation by the regulations.) Keep in mind that certain ownership attribution rules apply under the Code when determining who is a more-than-2% shareholder of an S corporation. These rules treat an individual as owning the S corporation stock that is owned by certain family members.
Finally, we should note that covering outside directors under your company’s benefit programs may raise other issues. For example, it is unclear whether a multiple employer welfare arrangement (MEWA) is created when health or other welfare benefits are provided to non-employee corporate directors.
For more information, see EBIA’s Cafeteria Plans manual at Sections IX.B.2 (“Self-Employed Individuals Cannot Participate (but Their Employee-Spouses and Other Family Members Who Are Employees May Participate, in Some Cases)”), IX.B.5 (“Outside Directors Generally Cannot Participate”), and IX.D (“Ownership Attribution Rules Under Code § 318”). See also EBIA’s ERISA Compliance manual at Section XIX.C.2.e (“It Is Unclear Whether Covering Corporate Directors Creates a MEWA”).
Contributing Editors: EBIA Staff.