A Section 125 plan, also known as a cafeteria plan, allows employees to pay for eligible benefits like health insurance or flexible spending accounts (FSAs) using pre-tax dollars. This reduces their taxable income and helps both employees and employers save on taxes.
Employers benefit from lower payroll taxes (FICA and FUTA), while employees receive more value through access to pre-tax benefits. In many cases, employees maintain or slightly increase their net take-home pay by reducing their taxable wages.
Employees select pre-tax benefit elections during open enrollment. These elections reduce their gross income, which in turn reduces the employer’s tax liability. Employers must maintain compliance with IRS rules and provide documentation like a plan document and Summary Plan Description (SPD).
Full-time W-2 employees are typically eligible. Independent contractors, sole proprietors, and more-than-2% S-corp shareholders are generally excluded under IRS regulations.
The term comes from the idea of a "menu" of benefit choices that employees can select from, much like choosing from items in a cafeteria. Each employee picks the combination of benefits that best suits their needs.
These include health insurance premiums, dental and vision coverage, FSAs, dependent care assistance, preventative care programs, and other qualified wellness benefits like telehealth or life insurance.
Traditional plans may involve post-tax contributions or limited pre-tax benefits. Section 125 plans specifically structure benefit payments to be pre-tax, offering higher tax savings and more control.
Yes—many small businesses with as few as 5 to 10 W-2 employees can set up a compliant Section 125 plan. These plans are scalable and customizable based on employer needs.
Yes, the IRS mandates a formal written plan document that details eligibility, benefits, and administrative rules. Employers must also distribute a Summary Plan Description (SPD) to all eligible employees.
Plans must not unfairly benefit highly compensated employees or key personnel. Annual nondiscrimination testing is required to confirm compliance and ensure all employees are treated fairly.
If the plan fails testing, the tax advantages for high-earning employees may be reversed, meaning their benefits could become taxable. The employer may also face penalties and IRS scrutiny.
Section 125 of the Internal Revenue Code governs cafeteria plans, outlining their requirements, tax advantages, and limitations. Employers must follow these rules to maintain compliance.
No annual filing is required with the IRS, but all documentation (plan document, SPD, testing results) must be kept on file in case of an audit or regulatory review.
Typical mistakes include not having a written plan document, failing to conduct annual nondiscrimination testing, or including non-qualified benefits in the plan.
Plans should be reviewed annually or whenever there are changes to benefit offerings, employment structure, or IRS regulations. Keeping documentation current is essential.
Yes, especially during a payroll or benefits audit. Having accurate and up-to-date documentation significantly reduces the risk of penalties or plan disqualification.
A POP is a simplified Section 125 plan that allows employees to pay health, dental, and vision insurance premiums with pre-tax dollars. It's easy to administer and provides immediate savings.
An FSA allows employees to contribute pre-tax dollars for healthcare or dependent care expenses. There are annual limits set by the IRS, and funds are generally use-it-or-lose-it.
FSAs are employer-owned, typically have annual forfeiture rules, and are compatible with many health plans. HSAs are employee-owned, portable, and must be paired with a High Deductible Health Plan (HDHP).
PCMPs offer a fully managed solution that includes telehealth, lab access, mental wellness, and other pre-tax preventative services. They're layered on top of existing benefits and have become increasingly popular for their simplicity and compliance.
Yes—group term life insurance up to $50,000, telemedicine, EAPs, and wellness services can be included if structured correctly under Section 125 rules.
Fully-managed PCMP plans are the most adopted structure today. They provide a turnkey solution for compliance, employee communication, and administration.
Employers typically save $600 to $1,200 per employee annually in payroll taxes by offering pre-tax benefits. For companies with 50+ employees, this can add up to tens of thousands in annual savings.
In most cases, employee net pay remains the same or increases slightly. A payroll and benefit review is often conducted during setup to ensure employees don’t see any drop in take-home pay.
Not at all. POPs and basic FSAs have low setup costs, and most PCMP-style plans have no upfront fees, as they’re funded through payroll tax savings.
Yes. Third-party administrators (TPAs) handle setup, documentation, enrollment, compliance testing, and ongoing employee support.
Depending on the provider and company readiness, implementation can take anywhere from 15 to 45 days, including compliance checks and employee onboarding.
The SPD is a required document that explains plan rules, eligibility, and benefits to employees in plain language. It must be distributed to all participants.
At minimum, you need a formal plan document, the SPD, annual nondiscrimination test results, and employee election or waiver forms.
The plan document is a legal and compliance tool, required by the IRS. The benefits guide is a user-friendly explanation meant to help employees understand and select their options.
A Section 125 plan, also known as a cafeteria plan, allows employees to pay for eligible benefits like health insurance or flexible spending accounts (FSAs) using pre-tax dollars. This reduces their taxable income and helps both employees and employers save on taxes.
Employers benefit from lower payroll taxes (FICA and FUTA), while employees receive more value through access to pre-tax benefits. In many cases, employees maintain or slightly increase their net take-home pay by reducing their taxable wages.
Employees select pre-tax benefit elections during open enrollment. These elections reduce their gross income, which in turn reduces the employer’s tax liability. Employers must maintain compliance with IRS rules and provide documentation like a plan document and Summary Plan Description (SPD).
Full-time W-2 employees are typically eligible. Independent contractors, sole proprietors, and more-than-2% S-corp shareholders are generally excluded under IRS regulations.
The term comes from the idea of a "menu" of benefit choices that employees can select from, much like choosing from items in a cafeteria. Each employee picks the combination of benefits that best suits their needs.
These include health insurance premiums, dental and vision coverage, FSAs, dependent care assistance, preventative care programs, and other qualified wellness benefits like telehealth or life insurance.
Traditional plans may involve post-tax contributions or limited pre-tax benefits. Section 125 plans specifically structure benefit payments to be pre-tax, offering higher tax savings and more control.
Yes—many small businesses with as few as 5 to 10 W-2 employees can set up a compliant Section 125 plan. These plans are scalable and customizable based on employer needs.
Yes, the IRS mandates a formal written plan document that details eligibility, benefits, and administrative rules. Employers must also distribute a Summary Plan Description (SPD) to all eligible employees.
Plans must not unfairly benefit highly compensated employees or key personnel. Annual nondiscrimination testing is required to confirm compliance and ensure all employees are treated fairly.
If the plan fails testing, the tax advantages for high-earning employees may be reversed, meaning their benefits could become taxable. The employer may also face penalties and IRS scrutiny.
Section 125 of the Internal Revenue Code governs cafeteria plans, outlining their requirements, tax advantages, and limitations. Employers must follow these rules to maintain compliance.
No annual filing is required with the IRS, but all documentation (plan document, SPD, testing results) must be kept on file in case of an audit or regulatory review.
Typical mistakes include not having a written plan document, failing to conduct annual nondiscrimination testing, or including non-qualified benefits in the plan.
Plans should be reviewed annually or whenever there are changes to benefit offerings, employment structure, or IRS regulations. Keeping documentation current is essential.
Yes, especially during a payroll or benefits audit. Having accurate and up-to-date documentation significantly reduces the risk of penalties or plan disqualification.
A POP is a simplified Section 125 plan that allows employees to pay health, dental, and vision insurance premiums with pre-tax dollars. It's easy to administer and provides immediate savings.
An FSA allows employees to contribute pre-tax dollars for healthcare or dependent care expenses. There are annual limits set by the IRS, and funds are generally use-it-or-lose-it.
FSAs are employer-owned, typically have annual forfeiture rules, and are compatible with many health plans. HSAs are employee-owned, portable, and must be paired with a High Deductible Health Plan (HDHP).
PCMPs offer a fully managed solution that includes telehealth, lab access, mental wellness, and other pre-tax preventative services. They're layered on top of existing benefits and have become increasingly popular for their simplicity and compliance.
Yes—group term life insurance up to $50,000, telemedicine, EAPs, and wellness services can be included if structured correctly under Section 125 rules.
Fully-managed PCMP plans are the most adopted structure today. They provide a turnkey solution for compliance, employee communication, and administration.
Employers typically save $600 to $1,200 per employee annually in payroll taxes by offering pre-tax benefits. For companies with 50+ employees, this can add up to tens of thousands in annual savings.
In most cases, employee net pay remains the same or increases slightly. A payroll and benefit review is often conducted during setup to ensure employees don’t see any drop in take-home pay.
Not at all. POPs and basic FSAs have low setup costs, and most PCMP-style plans have no upfront fees, as they’re funded through payroll tax savings.
Yes. Third-party administrators (TPAs) handle setup, documentation, enrollment, compliance testing, and ongoing employee support.
Depending on the provider and company readiness, implementation can take anywhere from 15 to 45 days, including compliance checks and employee onboarding.
The SPD is a required document that explains plan rules, eligibility, and benefits to employees in plain language. It must be distributed to all participants.
At minimum, you need a formal plan document, the SPD, annual nondiscrimination test results, and employee election or waiver forms.
The plan document is a legal and compliance tool, required by the IRS. The benefits guide is a user-friendly explanation meant to help employees understand and select their options.
Whether you're an HR manager, business owner, or employee, navigating Section 125 can be confusing. We're here to help.
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