[Congressional Record Volume 151, Number 38 (Wednesday, April 6, 2005)]
[Senate]
[Pages S3290-S3294]
From the Congressional Record Online through the Government Publishing Office [www.gpo.gov]

      By Ms. SNOWE (for herself, Mr. Bond, and Mr. Bingaman):
  S. 723. A bill to amend the Internal Revenue Code of 1986 to allow 
small businesses to set up simple cafeteria plans to provide nontaxable 
employee benefits to their employees, to make changes in the 
requirements for cafeteria plans, flexible spending accounts, and 
benefits provided under such plans or accounts, and for other purposes; 
to the Committee on Finance.
  Ms. SNOWE. Mr. President, I rise today to introduce the SIMPLE 
Cafeteria Plan Act of 2005'' to increase the access to quality, 
affordable health care for millions of small business owners and their 
employees. I am pleased that my good friend from Missouri, Senator 
Bond, as well as my good friend Senator Bingaman from New Mexico have 
agreed to co-sponsor this critical piece of legislation.
  Regrettably, our Nation's healthcare system is in the midst of a 
crisis. Each year, more and more Americans are unable to purchase 
health insurance, and there are no signs that things are improving. As 
evidence, the United States Census Bureau estimates that nearly 47 
million people did not have health insurance coverage for all of 2002. 
Sadly, this number rose from 41.2 million uninsured persons in 2001--a 
14.6 percent increase.
  As if these numbers on a national scale are not alarming enough, the 
results are even more troubling when we look specifically at the small 
business sector of our economy. Analysis conducted by the Employee 
Benefit Research Institute, a nonpartisan group dedicated to ensuring 
that all workers have access to affordable health care, suggests that 
the highest rates of uninsured occur among either self-employed workers 
or workers whose employer employees fewer than 25 persons. When 
compared to workers in firms that employ 1,000 or more employees, where 
just 12.6 percent of those workers do not have health insurance, it 
becomes clear that the majority of uninsured Americans work for small 
enterprises. Clearly, these numbers suggest that there is a direct 
correlation among those persons who do not have health insurance and 
the size of their employer.
  The question, then, is why are our Nation's small businesses, which 
are our country's job creators and the true engine of our national 
economy, so disadvantaged when it comes to purchasing health insurance.
  The main reason that small business owners are not able to offer 
their employees health insurance is because many small business owners 
are able to pay only a portion of their employees' health insurance 
premiums or, even worse, cannot afford to provide any health insurance 
or other employee benefits at all. As a result, many small business 
workers must acquire health insurance from the private sector rather 
than the work place--an unfair, and far more expensive alternative.
  Clearly, we have a problem on our hands. While we can debate among 
ourselves why this crisis exists and how we ended up here, what is not 
open for debate is that we need to start identifying ways to fix the 
system because it is simply unconscionable to do nothing while more and 
more Americans find themselves without health care.
  As you know, I re-introduced a bill earlier this year that will go a 
long ways towards improving the situation by creating Associated Health 
Plans for small businesses. In general, this bill would permit small 
businesses throughout the country to band together for purposes of 
obtaining an insurance quote from an insurance company. By pooling 
these businesses together, they would pay lower premiums because of the 
increased risk pool.
  Again, this bill would increase the number of Americans that would be 
able to afford health insurance because their insurance premiums would 
be based on a more reasonable number. The bill I am introducing today 
builds upon this and goes a step further by putting more small business 
owners and their employees on a level playing field when compared to 
workers of a larger company.
  Specifically, many large companies and even the Federal government 
enable their employees to purchase health insurance and other qualified 
benefits with taxfree dollars. Larger companies are able to do this by 
qualifying for certain employee benefit delivery mechanisms under the 
tax code.
  One such delivery mechanism is a cafeteria plan. As the name 
suggests, cafeteria plans are programs whereby employers offer their 
employees the opportunity to purchase certain qualified benefits of 
their choosing. The key here is that the employer provides the 
opportunity for the employee to purchase the benefit, and the employee 
is then free to chose whether to participate and which benefits to buy. 
Under current law, qualified benefits include health insurance, 
dependent-care reimbursement, and life and disability insurance. 
Typically, employer contributions, employee contributions, or a 
combination of the two fund these plans.
  Cafeteria plans offer valuable benefits to employees and are popular 
for many reasons. Specifically, they offer employees great flexibility 
in selecting their desired benefits while enabling them to disregard 
those benefits that do not fit their particular needs. Participating 
employees are also able to exclude any wages that they contribute to a 
cafeteria plan from their Federal taxable income, Social Security, and 
Medicare, which means they are using more valuable pre-tax dollars to 
buy these benefits. Moreover, the employees are usually purchasing 
these benefits at a lower cost because employers are oftentimes able to 
obtain a reduced price for the benefits through a group rate after they 
establish a cafeteria plan.
  Cafeteria plans also provide employers with valuable benefits, most 
notably as a recruiting tool. It certainly stands to reason that if 
more small business owners are able to offer their employees the chance 
to enjoy a variety of employee benefits, these owners

[[Page S3291]]

then will be more likely to attract, recruit, and retain more talented 
workers, which will ultimately increase the firm's business output. Too 
often, we hear that small businesses loose skilled employees to larger 
companies simply because a big firm is able to offer a more attractive 
benefit package. Given that small businesses are responsible for a 
majority of the new jobs created in this country, we need to reverse 
that trend, and this bill will go a long way in rectifying this 
inequity.
  Clearly, cafeteria plans play a critical role in our Nation's health 
care system and economy in general. The problem, though, is that in 
order for companies to qualify for the tax benefits that cafeteria 
plans provide, they must satisfy strict nondiscrimination rules under 
the tax code. These rules exist to ensure that the benefits offered to 
highly compensated employees are offered to non-highly compensated 
employees as well. The rules also strive to ensure that non-highly 
compensated employees in fact receive a substantial portion of the 
benefits provided under the plan.
  Now I want to be clear when I say that these non-discrimination rules 
serve a legitimate purpose. Indeed, we need to be sure that employers 
are not able to game the tax system by implementing these cafeteria 
plans, and that the cafeteria plans that qualify for preferential tax 
treatment are used by a majority of the employees in the company.
  However, what I find to be unacceptable is the way the tax code 
attempts to implement this policy under the existing rules. Currently, 
many small businesses simply cannot satisfy these mechanical rules 
because, through no fault of their own, they have relatively few 
employees and a high proportion of owners or highly compensated 
individuals. As such, were a small business to create a cafeteria plan 
and violate the non-discrimination rules, certain workers within the 
company would be subject to a penalty and would be required to include 
a substantial portion of their contributions in their taxable income.
  Consequently, many small companies simply do not even bother to 
implement a cafeteria plan for fear that they will violate the non-
discrimination rules. According to the Employer's Council on Flexible 
Compensation, while 38.36 million U.S. workers had access to cafeteria 
plans in 1999, only 19 percent of those workers were employees of small 
businesses.
  To improve the current situation, the bill I am introducing today 
will allow and encourage more small businesses to offer employees the 
opportunity to purchase health insurance with tax-free dollars just as 
larger companies and the federal government do. My bill accomplishes 
this by creating a Simple Cafeteria Plan, which is modeled after the 
Savings Incentive Match Plan for Employees (SIMPLE) pension plan. As 
with the SIMPLE pension plan, a small business employer that is willing 
to make a minimum contribution for all employees or who is willing to 
match contributions will be permitted to waive the non-discrimination 
rules that currently prevent these owners from otherwise offering these 
benefits. This structure has worked extraordinarily well in the pension 
area with little risk of abuse, and I am confident that it will be just 
as successful when it comes to broad-based benefits offered through 
cafeteria plans.

  Under the SIMPLE Cafeteria Plan, small companies will not have to 
struggle with satisfying the burdensome non-discrimination rules that 
often prevent them from offering valuable employee benefits to their 
workers. As a result, more small business employers will be able to 
provide their workers with the employee benefits that are often 
reserved for larger employers and that are otherwise unavailable 
because of the non-discrimination rules.
  In addition my bill will expand the types of qualified benefits that 
will be able to be offered under ALL cafeteria plans--both those that 
qualify under existing law as well as the new SIMPLE cafeteria plans 
that will be created. Specifically, my bill modifies the rules 
governing benefits offered under cafeteria plans, such as flexible 
spending accounts and dependent-care assistance plans that many larger 
employers offer their employees. These modifications will increase the 
likelihood that employees of small businesses will utilize the 
available benefits and that will increase the benefits provided for all 
employees.
  For example, current rules impose a ``use it or lose it'' requirement 
with respect to flexible spending arrangement contributions. This means 
that the employee forfeits any money he or she contributes to the 
account but does not use during the plan. My bill would change that 
rule and allow employees to carry over up to $500 remaining in their 
account to the next plan year. The bill would also permit employees to 
carry-over any unused funds to a retirement account such as a 401(k) 
plan.
  In either case, any carried over contributions will reduce the amount 
that the employee otherwise would be able to contribute to the spending 
arrangement in the following year so that the carry-over option will 
not produce a greater dollar benefit for any employee. As a result, 
more employees are likely to participate in these spending arrangements 
because they will ultimately be able to use any funds that they 
contribute without any fear of forfeiting them simply because the funds 
were not used in the year of contribution.
  Additionally, this legislation modifies rules that pertain to 
employer-provided, dependent-care assistance plans. First, it would 
increase the current $5,000 annual contribution limitation of these 
plans to $10,000 if the contributing employee claims two or more 
dependents on his or her tax return. This increase is significant 
because it will provide these taxpayers with an opportunity to care for 
not only their children but also an elderly family member who is a 
dependent of an employee--a scenario that will become increasingly more 
likely as the current baby-boomer generation continues to age.
  Second, this bill would amend the current non-discrimination rules 
that dependent-care assistance plans must satisfy. As is often the case 
with the majority of small business owners who cannot, through any 
fault of their own, satisfy the non-discrimination rules for 
establishing a cafeteria plan, these rules often prevent the owner from 
offering this valuable benefit to their employees. To remedy this 
inequity, this bill would change the current mechanical thresholds such 
that more small businesses can provide dependent-care assistance plans 
to their employees but in a manner that does not encourage the type of 
abuse that the non-discrimination rules are intended to prevent.
  Small businesses are the backbone of the American economy. According 
to the Small Business Administration, small businesses represent 99 
percent of all employers, employ 51 percent of the private-sector 
workforce, and contribute 51 percent of the private-sector output. It 
is therefore critical that small businesses owners are able to offer 
their employees the benefits that cafeteria plans provide so that more 
of our nation's workers have the opportunity to purchase quality 
healthcare and provide security for their families.
  The ``SIMPLE Cafeteria Plan Act of 2005'' achieves those objectives, 
and it does so in a manner that the employers and employees are able to 
afford. Although the use of pre-tax dollars to acquire these benefits 
reduces current federal revenues, the opportunity to provide small 
business employees these same benefits to workers and their families 
rather than relying on the public sector more than justifies this 
minimal investment. Therefore, I urge my colleagues to join me in 
supporting this important legislation as we work with you to enact this 
bill into law.
  I ask unanimous consent that the text of the bill be printed in the 
Record.
  There being no objection, the bill was ordered to be printed in the 
Record, as follows:

                                 S. 723

       Be it enacted by the Senate and House of Representatives of 
     the United States of America in Congress assembled,

     SECTION 1. SHORT TITLE.

       (a) Short Title.--This Act may be cited as the ``SIMPLE 
     Cafeteria Plan Act of 2005'' .
       (b) Amendment of 1986 Code.--Except as otherwise expressly 
     provided, whenever in this Act an amendment or repeal is 
     expressed in terms of an amendment to, or repeal of, a 
     section or other provision, the reference shall be considered 
     to be made to a section or other provision of the Internal 
     Revenue Code of 1986.

     SEC. 2. ESTABLISHMENT OF SIMPLE CAFETERIA PLANS FOR SMALL 
                   BUSINESSES.

       (a) In General.--Section 125 (relating to cafeteria plans) 
     is amended by redesignating

[[Page S3292]]

     subsections (h) and (i) as subsections (i) and (j), 
     respectively, and by inserting after subsection (g) the 
     following new subsection:
       ``(h) Simple Cafeteria Plans for Small Businesses.--
       ``(1) In general.--An eligible employer maintaining a 
     simple cafeteria plan with respect to which the requirements 
     of this subsection are met for any year shall be treated as 
     meeting any applicable nondiscrimination requirement with 
     respect to benefits provided under the plan during such year.
       ``(2) Simple cafeteria plan.--For purposes of this 
     subsection, the term `simple cafeteria plan' means a 
     cafeteria plan--
       ``(A) which is established and maintained by an eligible 
     employer, and
       ``(B) with respect to which the contribution requirements 
     of paragraph (3), and the eligibility and participation 
     requirements of paragraph (4), are met.
       ``(3) Contributions requirements.--
       ``(A) In general.--The requirements of this paragraph are 
     met if, under the plan--
       ``(i) the employer makes matching contributions on behalf 
     of each employee who is eligible to participate in the plan 
     and who is not a highly compensated or key employee in an 
     amount equal to the elective plan contributions of the 
     employee to the plan to the extent the employee's elective 
     plan contributions do not exceed 3 percent of the employee's 
     compensation, or
       ``(ii) the employer is required, without regard to whether 
     an employee makes any elective plan contribution, to make a 
     contribution to the plan on behalf of each employee who is 
     not a highly compensated or key employee and who is eligible 
     to participate in the plan in an amount equal to at least 2 
     percent of the employee's compensation.
       ``(B) Matching contributions on behalf of highly 
     compensated and key employees.--The requirements of 
     subparagraph (A)(i) shall not be treated as met if, under the 
     plan, the rate of matching contribution with respect to any 
     elective plan contribution of a highly compensated or key 
     employee at any rate of contribution is greater than that 
     with respect to an employee who is not a highly compensated 
     or key employee.
       ``(C) Special rules.--
       ``(i) Time for making contributions.--An employer shall not 
     be treated as failing to meet the requirements of this 
     paragraph with respect to any elective plan contributions of 
     any compensation, or employer contributions required under 
     this paragraph with respect to any compensation, if such 
     contributions are made no later than the 15th day of the 
     month following the last day of the calendar quarter which 
     includes the date of payment of the compensation.
       ``(ii) Form of contributions.--Employer contributions 
     required under this paragraph may be made either to the plan 
     to provide benefits offered under the plan or to any person 
     as payment for providing benefits offered under the plan.
       ``(iii) Additional contributions.--Subject to subparagraph 
     (B), nothing in this paragraph shall be treated as 
     prohibiting an employer from making contributions to the plan 
     in addition to contributions required under subparagraph (A).
       ``(D) Definitions.--For purposes of this paragraph--
       ``(i) Elective plan contribution.--The term `elective plan 
     contribution' means any amount which is contributed at the 
     election of the employee and which is not includible in gross 
     income by reason of this section.
       ``(ii) Highly compensated employee.--The term `highly 
     compensated employee' has the meaning given such term by 
     section 414(q).
       ``(iii) Key employee.--The term `key employee' has the 
     meaning given such term by section 416(i).
       ``(4) Minimum eligibility and participation requirements.--
       ``(A) In general.--The requirements of this paragraph shall 
     be treated as met with respect to any year if, under the 
     plan--
       ``(i) all employees who had at least 1,000 hours of service 
     for the preceding plan year are eligible to participate, and
       ``(ii) each employee eligible to participate in the plan 
     may, subject to terms and conditions applicable to all 
     participants, elect any benefit available under the plan.
       ``(B) Certain employees may be excluded.--For purposes of 
     subparagraph (A)(i), an employer may elect to exclude under 
     the plan employees--
       ``(i) who have less than 1 year of service with the 
     employer as of any day during the plan year,
       ``(ii) who have not attained the age of 21 before the close 
     of a plan year,
       ``(iii) who are covered under an agreement which the 
     Secretary of Labor finds to be a collective bargaining 
     agreement if there is evidence that the benefits covered 
     under the cafeteria plan were the subject of good faith 
     bargaining between employee representatives and the employer, 
     or
       ``(iv) who are described in section 410(b)(3)(C) (relating 
     to nonresident aliens working outside the United States).

     A plan may provide a shorter period of service or younger age 
     for purposes of clause (i) or (ii).
       ``(5) Eligible employer.--For purposes of this subsection--
       ``(A) In general.--The term `eligible employer' means, with 
     respect to any year, any employer if such employer employed 
     an average of 100 or fewer employees on business days during 
     either of the 2 preceding years. For purposes of this 
     subparagraph, a year may only be taken into account if the 
     employer was in existence throughout the year.
       ``(B) Employers not in existence during preceding year.--If 
     an employer was not in existence throughout the preceding 
     year, the determination under subparagraph (A) shall be based 
     on the average number of employees that it is reasonably 
     expected such employer will employ on business days in the 
     current year.
       ``(C) Growing employers retain treatment as small 
     employer.--If--
       ``(i) an employer was an eligible employer for any year (a 
     `qualified year'), and
       ``(ii) such employer establishes a simple cafeteria plan 
     for its employees for such year, then, notwithstanding the 
     fact the employer fails to meet the requirements of 
     subparagraph (A) for any subsequent year, such employer shall 
     be treated as an eligible employer for such subsequent year 
     with respect to employees (whether or not employees during a 
     qualified year) of any trade or business which was covered by 
     the plan during any qualified year. This subparagraph shall 
     cease to apply if the employer employs an average of 200 more 
     employees on business days during any year preceding any such 
     subsequent year.
       ``(D) Special rules.--The rules of section 220(c)(4)(D) 
     shall apply for purposes of this paragraph.
       ``(6) Applicable nondiscrimination requirement.--For 
     purposes of this subsection, the term `applicable 
     nondiscrimination requirement' means any requirement under 
     subsection (b) of this section, section 79(d), section 
     105(h), or paragraph (2), (3), (4), or (8) of section 129(d).
       ``(7) Compensation.--The term `compensation' has the 
     meaning given such term by section 414(s).''
       (b) Effective Date.--The amendments made by this section 
     shall apply to years beginning after December 31, 2004.

     SEC. 3. MODIFICATIONS OF RULES APPLICABLE TO CAFETERIA PLANS.

       (a) Application to Self-Employed Individuals.--
       (1) In general.--Section 125(d) (defining cafeteria plan) 
     is amended by adding at the end the following new paragraph:
       ``(3) Employee to include self-employed.--
       ``(A) In general.--The term `employee' includes an 
     individual who is an employee within the meaning of section 
     401(c)(1) (relating to self-employed individuals).
       ``(B) Limitation.--The amount which may be excluded under 
     subsection (a) with respect to a participant in a cafeteria 
     plan by reason of being an employee under subparagraph (A) 
     shall not exceed the employee's earned income (within the 
     meaning of section 401(c)) derived from the trade or business 
     with respect to which the cafeteria plan is established.''
       (2) Application to benefits which may be provided under 
     cafeteria plan.--
       (A) Group-term life insurance.--Section 79 (relating to 
     group-term life insurance provided to employees) is amended 
     by adding at the end the following new subsection:
       ``(f) Employee Includes Self-Employed.--
       ``(1) In general.--For purposes of this section, the term 
     `employee' includes an individual who is an employee within 
     the meaning of section 401(c)(1) (relating to self-employed 
     individuals).
       ``(2) Limitation.--The amount which may be excluded under 
     the exceptions contained in subsection (a) or (b) with 
     respect to an individual treated as an employee by reason of 
     paragraph (1) shall not exceed the employee's earned income 
     (within the meaning of section 401(c)) derived from the trade 
     or business with respect to which the individual is so 
     treated.''
       (B) Accident and health plans.--Section 105(g) is amended 
     to read as follows:
       ``(g) Employee Includes Self-Employed.--
       ``(1) In general.--For purposes of this section, the term 
     `employee' includes an individual who is an employee within 
     the meaning of section 401(c)(1) (relating to self-employed 
     individuals).
       ``(2) Limitation.--The amount which may be excluded under 
     this section by reason of subsection (b) or (c) with respect 
     to an individual treated as an employee by reason of 
     paragraph (1) shall not exceed the employee's earned income 
     (within the meaning of section 401(c)) derived from the trade 
     or business with respect to which the accident or health 
     insurance was established.''
       (C) Contributions by employers to accident and health 
     plans.--
       (i) In general.--Section 106, as amended by subsection (b), 
     is amended by adding after subsection (b) the following new 
     subsection:
       ``(c) Employer to Include Self-Employed.--
       ``(1) In general.--For purposes of this section, the term 
     `employee' includes an individual who is an employee within 
     the meaning of section 401(c)(1) (relating to self-employed 
     individuals).
       ``(2) Limitation.--The amount which may be excluded under 
     subsection (a) with respect to an individual treated as an 
     employee by reason of paragraph (1) shall not exceed the 
     employee's earned income (within the meaning of section 
     401(c)) derived from the trade or business with respect to 
     which the accident or health insurance was established.''
       (ii) Clarification of limitations on other coverage.--The 
     first sentence of section 162(l)(2)(B) is amended to read as 
     follows:

[[Page S3293]]

     ``Paragraph (1) shall not apply to any taxpayer for any 
     calendar month for which the taxpayer participates in any 
     subsidized health plan maintained by any employer (other than 
     an employer described in section 401(c)(4)) of the taxpayer 
     or the spouse of the taxpayer.
       (b) Long-Term Care Insurance Permitted to Be Offered Under 
     Cafeteria Plans and Flexible Spending Arrangements.--
       (1) Cafeteria plans.--The last sentence of section 125(f) 
     (defining qualified benefits) is amended to read as follows: 
     ``Such term shall include the payment of premiums for any 
     qualified long-term care insurance contract (as defined in 
     section 7702B) to the extent the amount of such payment does 
     not exceed the eligible long-term care premiums (as defined 
     in section 213(d)(10)) for such contract''.
       (2) Flexible spending arrangements.--Section 106 (relating 
     to contributions by employer to accident and health plans) is 
     amended by striking subsection (c).
       (c) Effective Date.--The amendments made by this section 
     shall apply to taxable years beginning after December 31, 
     2004.

     SEC. 4. MODIFICATION OF RULES APPLICABLE TO FLEXIBLE SPENDING 
                   ARRANGEMENTS.

       (a) In General.--Section 125, as amended by section 2, is 
     amended by redesignating subsections (i) and (j) as 
     subsections (j) and (k), respectively, and by inserting after 
     subsection (h) the following new subsection:
       ``(i) Special Rules Applicable to Flexible Spending 
     Arrangements.--
       ``(1) In general.--For purposes of this title, a plan or 
     other arrangement shall not fail to be treated as a flexible 
     spending or similar arrangement solely because under the plan 
     or arrangement--
       ``(A) the amount of the reimbursement for covered expenses 
     at any time may not exceed the balance in the participant's 
     account for the covered expenses as of such time,
       ``(B) except as provided in paragraph (4)(A)(ii), a 
     participant may elect at any time specified by the plan or 
     arrangement to make or modify any election regarding the 
     covered benefits, or the level of covered benefits, of the 
     participant under the plan, and
       ``(C) a participant is permitted access to any unused 
     balance in the participant's accounts under such plan or 
     arrangement in the manner provided under paragraph (2) or 
     (3).
       ``(2) Carryovers and rollovers of unused benefits in health 
     and dependent care arrangements.--
       ``(A) In general.--A plan or arrangement may permit a 
     participant in a health flexible spending arrangement or 
     dependent care flexible spending arrangement to elect--
       ``(i) to carry forward any aggregate unused balances in the 
     participant's accounts under such arrangement as of the close 
     of any year to the succeeding year, or
       ``(ii) to have such balance transferred to a plan described 
     in subparagraph (E).

     Such carryforward or transfer shall be treated as having 
     occurred within 30 days of the close of the year.
       ``(B) Dollar limit on carryforwards.--
       ``(i) In general.--The amount which a participant may elect 
     to carry forward under subparagraph (A)(i) from any year 
     shall not exceed $500. For purposes of this paragraph, all 
     plans and arrangements maintained by an employer or any 
     related person shall be treated as 1 plan.
       ``(ii) Cost-of-living adjustment.--In the case of any 
     taxable year beginning in a calendar year after 2005, the 
     $500 amount under clause (i) shall be increased by an amount 
     equal to--

       ``(I) $500, multiplied by
       ``(II) the cost-of-living adjustment determined under 
     section 1(f)(3) for such calendar year, determined by 
     substituting `2004' for `1992' in subparagraph (B) thereof.

     If any dollar amount as increased under this clause is not a 
     multiple of $100, such amount shall be rounded to the next 
     lowest multiple of $100.
       ``(C) Exclusion from gross income.--No amount shall be 
     required to be included in gross income under this chapter by 
     reason of any carryforward or transfer under this paragraph.
       ``(D) Coordination with limits.--
       ``(i) Carryforwards.--The maximum amount which may be 
     contributed to a health flexible spending arrangement or 
     dependent care flexible spending arrangement for any year to 
     which an unused amount is carried under this paragraph shall 
     be reduced by such amount.
       ``(ii) Rollovers.--Any amount transferred under 
     subparagraph (A)(ii) shall be treated as an eligible rollover 
     under section 219, 223(f)(5), 401(k), 403(b), or 457, 
     whichever is applicable, except that--

       ``(I) the amount of the contributions which a participant 
     may make to the plan under any such section for the taxable 
     year including the transfer shall be reduced by the amount 
     transferred, and
       ``(II) in the case of a transfer to a plan described in 
     clause (ii) or (iii) of subparagraph (E), the transferred 
     amounts shall be treated as elective deferrals for such 
     taxable year.

       ``(E) Plans.--A plan is described in this subparagraph if 
     it is--
       ``(i) an individual retirement plan,
       ``(ii) a qualified cash or deferred arrangement described 
     in section 401(k),
       ``(iii) a plan under which amounts are contributed by an 
     individual's employer for an annuity contract described in 
     section 403(b),
       ``(iv) an eligible deferred compensation plan described in 
     section 457, or
       ``(v) a health savings account described in section 223.
       ``(3) Distribution upon termination.--
       ``(A) In general.--A plan or arrangement may permit a 
     participant (or any designated heir of the participant) to 
     receive a cash payment equal to the aggregate unused account 
     balances in the plan or arrangement as of the date the 
     individual is separated (including by death or disability) 
     from employment with the employer maintaining the plan or 
     arrangement.
       ``(B) Inclusion in income.--Any payment under subparagraph 
     (A) shall be includible in gross income for the taxable year 
     in which such payment is distributed to the employee.
       ``(4) Terms relating to flexible spending arrangements.--
       ``(A) Flexible spending arrangements.--
       ``(i) In general.--For purposes of this subsection, a 
     flexible spending arrangement is a benefit program which 
     provides employees with coverage under which specified 
     incurred expenses may be reimbursed (subject to reimbursement 
     maximums and other reasonable conditions).
       ``(ii) Elections required.--A plan or arrangement shall not 
     be treated as a flexible spending arrangement unless a 
     participant may at least 4 times during any year make or 
     modify any election regarding covered benefits or the level 
     of covered benefits.
       ``(B) Health and dependent care arrangements.--The terms 
     `health flexible spending arrangement' and `dependent care 
     flexible spending arrangement' means any flexible spending 
     arrangement (or portion thereof) which provides payments for 
     expenses incurred for medical care (as defined in section 
     213(d)) or dependent care (within the meaning of section 
     129), respectively.''
       (b) Conforming Amendment.--
       (1) The heading for section 125 is amended by inserting 
     ``And flexible spending arrangements'' after ``Plans''.
       (2) The item relating to section 125 in the table of 
     sections for part III of subchapter B of chapter 1 is amended 
     by inserting ``and flexible spending arrangements'' after 
     ``plans''.
       (c) Effective Date.--The amendments made by this section 
     shall apply to years beginning after December 31, 2004.

     SEC. 5. RULES RELATING TO EMPLOYER-PROVIDED HEALTH AND 
                   DEPENDENT CARE BENEFITS.

       (a) Health Benefits.--Section 106, as amended by section 3, 
     is amended by adding at the end the following new subsection:
       ``(e) Limitation on Contributions to Health Flexible 
     Spending Arrangements.--
       ``(1) In general.--Gross income of an employee for any 
     taxable year shall include employer-provided coverage 
     provided through 1 or more health flexible spending 
     arrangements (within the meaning of section 125(i)) to the 
     extent that the amount otherwise excludable under subsection 
     (a) with regard to such coverage exceeds the applicable 
     dollar limit for the taxable year.
       ``(2) Applicable dollar limit.--For purposes of this 
     subsection--
       ``(A) In general.--The applicable dollar limit for any 
     taxable year is an amount equal to the sum of--
       ``(i) $7,500, plus
       ``(ii) if the arrangement provides coverage for 1 or more 
     individuals in addition to the employee, an amount equal to 
     one-third of the amount in effect under clause (i) (after 
     adjustment under subparagraph (B)).
       ``(B) Cost-of-living adjustment.--In the case of taxable 
     years beginning in any calendar year after 2005, the $7,500 
     amount under subparagraph (A) shall be increased by an amount 
     equal to--
       ``(i) $7,500, multiplied by
       ``(ii) the cost-of-living adjustment determined under 
     section 1(f)(3) for the calendar year, determined by 
     substituting `2004' for `1992' in subparagraph (B) thereof.

     If any dollar amount as increased under this subparagraph is 
     not a multiple of $100, such dollar amount shall be rounded 
     to the next lowest multiple of $100.''
       (b) Dependent Care.--
       (1) Exclusion limit.--
       (A) In general.--Section 129(a)(2) (relating to limitation 
     on exclusion) is amended--
       (i) by striking ``$5,000'' and inserting ``the applicable 
     dollar limit'', and
       (ii) by striking ``$2,500'' and inserting ``one-half of 
     such limit''.
       (B) Applicable dollar limit.--Section 129(a) is amended by 
     adding at the end the following new paragraph:
       ``(3) Applicable dollar limit.--For purposes of this 
     subsection--
       ``(A) In general.--The applicable dollar limit is $5,000 
     ($10,000 if dependent care assistance is provided under the 
     program to 2 or more qualifying individuals of the employee).
       ``(B) Cost-of-living adjustments.--
       ``(i) $5,000 amount.--In the case of taxable years 
     beginning after 2005, the $5,000 amount under subparagraph 
     (A) shall be increased by an amount equal to--

       ``(I) $5,000, multiplied by
       ``(II) the cost-of-living adjustment determined under 
     section 1(f)(3) for the calendar year in which the taxable 
     year begins, determined by substituting `2004' for `1992' in 
     subparagraph (B) thereof.

     If any dollar amount as increased under this clause is not a 
     multiple of $100, such dollar amount shall be rounded to the 
     next lowest multiple of $100.
       ``(ii) $10,000 amount.--The $10,000 amount under 
     subparagraph (A) for taxable years beginning after 2005 shall 
     be increased to an

[[Page S3294]]

     amount equal to twice the amount the $5,000 amount is 
     increased to under clause (i).''
       (2) Average benefits test.--
       (A) In general.--Section 129(d)(8)(A) (relating to 
     benefits) is amended--
       (i) by striking ``55 percent'' and inserting ``60 
     percent'', and
       (ii) by striking ``highly compensated employees'' the 
     second place it appears and inserting ``employees receiving 
     benefits''.
       (B) Salary reduction agreements.--Section 129(d)(8)(B) 
     (relating to salary reduction agreements) is amended--
       (i) by striking ``$25,000'' and inserting ``$30,000'', and
       (ii) by adding at the end the following: ``In the case of 
     years beginning after 2005, the $30,000 amount in the first 
     sentence shall be adjusted at the same time, and in the same 
     manner, as the applicable dollar amount is adjusted under 
     subsection (a)(3)(B).''
       (3) Principal shareholders or owners.--Section 129(d)(4) 
     (relating to principal shareholders and owners) is amended by 
     adding at the end the following: ``In the case of any failure 
     to meet the requirements of this paragraph for any year, 
     amounts shall only be required by reason of the failure to be 
     included in gross income of the shareholders or owners who 
     are members of the class described in the preceding 
     sentence.''
       (c) Effective Date.--The amendments made by this section 
     shall apply to taxable years beginning after December 31, 
     2004.
                                 ______