Introduction
A Section 125 Plan, also known as a Cafeteria Plan, is an IRS-approved benefits program that allows employees to pay for certain expenses pre-tax, reducing both income tax and payroll tax liabilities. These plans benefit both employers and employees by providing cost savings while maintaining compliance with IRS Code Section 125.
What Is a Section 125 Cafeteria Plan?
A Cafeteria Plan (Section 125 Plan) enables employees to allocate a portion of their pre-tax salary toward:
- Health insurance premiums (medical, dental, vision)
- Flexible Spending Accounts (FSA)
- Health Savings Accounts (HSA)
- Dependent care expenses
- Other IRS-eligible benefits
How Do Section 125 Plans Benefit Employers and Employees?
For Employers:
- Lower payroll taxes – Save an average of $600-$700 per W2 employee per year.
- IRS-compliant tax savings – Reduce taxable payroll without increasing employee salaries.
- Higher employee retention – A competitive benefits package improves job satisfaction.
For Employees:
- Tax savings – Employees pay for medical expenses before taxes, reducing taxable income.
- Lower healthcare costs – Contributions to FSAs, HSAs, and insurance premiums are tax-free.
- More take-home pay – By reducing taxable income, employees keep more earnings in their paycheck.
IRS Section 125 Plan Compliance & Requirements
To ensure compliance, a Section 125 Plan must meet these IRS regulations:
- Formal written plan document
- Nondiscrimination testing (ensuring fair benefits distribution)
- Eligible benefit expenses must comply with IRS Code Section 125
Final Thoughts
A Section 125 Cafeteria Plan is an effective, IRS-approved way to reduce taxable income while enhancing employee benefits. Employers benefit from payroll tax savings, and employees enjoy pre-tax savings on essential expenses.
Interested in implementing a Section 125 Plan? Contact us today for a free consultation.
