How are vacations handled when there is a cafeteria plan?

Vacation buying and selling is an option available to employers with cafeteria plans (sometimes called flex plans). In terms of total compensation, the idea is a simple one. Under a cafeteria plan, an employee has a certain amount of money to spend on benefits or allocate to pay and can choose his or her purchases based on needs.

Most employers do not include vacation in a cafeteria plan, but the practice may on the rise. For those employers who do offer vacation buying and selling as a cafeteria plan option, a certain number of vacation days are typically allocated to employees outside of the cafeteria plan. Employees may then sell some (or all) of their days in order to increase their salaries or to buy additional vacation days with the flex dollars allocated to them to purchase benefits. Where applicable, vacation days can be priced either at a flat price for all employees or at a varying price depending on the employee's salary.

Can purchased vacation days be carried over? By including elective vacation days in a cafeteria plan, a plan may be impermissibly allowing employees to defer compensation (something cafeteria plans cannot do), unless the plan complies with rules governing the order of vacation days and the method of cashing out unused days.

Employees who purchase vacation days for a plan year may not be allowed to use any unused elective days in a subsequent plan year. A plan that allows a participant to carry over elective days effectively permits employees to carry over unused elective contributions from one plan year to another, which constitutes a deferral of income. Employers generally satisfy the no-carryover rule by requiring either year-end forfeitures or cash-outs of unused elective days.

A participant may also receive other forms of benefits in exchange for the vacation days. However, the participant must receive the cash or other benefit on or before the earlier of:

1. the last day of the cafeteria plan's plan year, or

2. the last day of the employee's tax year to which the elective contributions used to purchase the unused days relate.

What about nonelective days? Can they be carried over? Nonelective days are not considered to be part of the cafeteria plan and may be carried over to a later plan year. Nonelective vacation days are vacation days with respect to which the employee has no election.

How can an employer comply with the no-carryover rule? To comply with the rules governing vacation days in a cafeteria plan, employers should:

• differentiate between employees' elective and nonelective vacation days;

• track the number of elective and nonelective vacation days;

• not allow employees to carry forward any elective vacation time;

• cash out unused elective days for employees, if the plan permits cashouts.