Flexible Spending Arrangements (FSAs) and Cafeteria Plans are generally interchangeable from a naming convention. However it is listed under 26 U.S. Code Section 125 titled Cafeteria Plans. More exciting code at-
A lot of people are familiar with Section 125 Cafeteria Plans since most companies offer them for their employees to deduct health insurance premiums, medical expenses and dependent care on a pre-tax basis. There is even an allowance for transportation expenses for certain commuting people. This is a huge savings since you get the tax deduction instantly, and there are no income limitations or thresholds. Here are some numbers that demonstrate the savings-
By deducting the expenses through a Section 125 Cafeteria Plan, your savings are good at lower incomes and huge at larger incomes. However without a Cafeteria Plan you are relegated to deducting medical expenses on Schedule A, and subsequently the first 10% of your income is disallowed and only those medical expenses exceeding 10% of your income are deductible. That explains the difference show above.
Cafeteria Plans are not available to sole proprietors, single member LLCs, partners and S Corporation shareholders who own more than 2% of the company. However, you are entitled to hire your spouse who can enjoy this benefit subject to discrimination testing. Gotta love a good old fashioned loophole.
Note- participants are NOT all eligible employees. You only pay for those who are participating in the program.
Use or Lose It
However, there is an interesting caveat to the use or lose it system- if you lose the money because you didn’t have enough qualified medical expenses, the money is returned to the company as ordinary income. Whereas if you worked for a larger company that you did not own, the money would essentially be lost. But when you own the company the money returns to the company, is taxed (since it was once deducted), and it is yours to use.
Starting in 2014, Cafeteria Plans can either extend reimbursements until March 15 or allow you to rollover $500 to the next year. This is an either/or option within the plan covering all employees (not user selected).
Taxpayer's Comprehensive Guide to LLCs and S Corps