Section 125 – Cafeteria Plans Overview
A Section 125 plan, or a cafeteria plan, allows employees to pay for certain benefits on a pre-tax basis. Specifically, employers use these plans to provide their employees with a choice between cash and certain qualified benefits without adverse tax consequences. Paying for benefits on a pre-tax basis reduces the employees’ taxable income and therefore reduces both the employees’ and the employer’s tax liability.
In order to receive these tax advantages, a cafeteria plan must comply with the rules of Internal Revenue Code (Code) Section 125 and related Internal Revenue Service (IRS) regulations. Under these rules, a Section 125 plan must have a written plan document and can only offer certain qualified benefits on a tax-favored basis.
In addition, once an employee makes a Section 125 plan election, he or she may not change that election until the next plan year, unless the employee experiences a permitted election change event. Also, in order for highly compensated employees to receive the tax advantages associated with a Section 125 plan, the plan must generally pass certain nondiscrimination tests. More
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In order to offer Section 125 premium pre-taxing to employees, an employer must 1) adopt a plan document, 2) create and properly distribute the summary plan discrimination (SPD), 3) properly communicate this benefit to employees, and 4) conduct annual non-discrimination testing.
The employer must also conduct annual testing for compliance. The plan must pass three tests: 1) Eligibility to Participate, 2) Benefits and Contributions Test, and 3) The Key Employee Concentration Test.
Section 125: Cafeteria Plan Common Questions
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Green Financial Provides:
- Plan Documents & Updated Documents
- Summary Plan Documents (SPD) for Distribution
- Annual Non-Discrimination Testing
- Electronic Distribution System for all Notices
Key Legal Requirements
To receive a federal tax advantage, Section 125 plans must comply with the following legal rules:
- Must have a written plan document;
- Only common law employees may participate on pre-tax basis;
- Elections are generally irrevocable for entire plan year; and
- Must pass certain nondiscrimination tests.
Examples of Qualified Benefits
- Group health plan coverage
- Dental and vision benefits
- Health FSA
- Life insurance
- Disability benefits
- Adoption assistance