Section 125

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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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
  • DCAP
  • Life insurance
  • Disability benefits
  • Adoption assistance