Section 125 of the Internal Revenue Code: Cafeteria Plans
What is a section 125 Plan?
Cafeteria Plan is a plan wherein employers can choose to have either taxable or non-taxable benefits.
Note: A plan wherein employees may choose ONLY taxable plans is NOT a section 125 plan.
Who can sponsor a Section 125 Plan?
ALL US employers who have employees subject to income taxes can sponsor a section 125 plan. (ex. Sole proprietorships, Partnerships, Limited liability companies (LLC),
C corporations, S corporations, Government entities).
What is a Cafeteria Plan?
- It is a plan maintained by an employer that meets specific requirements of Section 125 of the IRC.
- Gives employees an option to either receive benefits in cash or certain benefits on a pre- tax basis.
- Employees MUST have the option to choose either 1 taxable benefit (cash) or 1 qualified
benefit. If not, it is NOT considered a cafeteria plan.
What is a qualified benefit?
- Benefit that does NOT defer compensation and is EXCLUDABLE from gross income.
-
Accident and health benefits (but not Archer medical savings accounts or long-term care insurance)
-
Adoption assistance
-
Dependent care assistance
-
Group-term life insurance coverage
-
Health savings accounts, including distributions to pay long-term care services (MUST be enrolled in a HDHP).
What are the most common types of cafeteria plans?
- Premium-only plan (POP) With a POP plan, employees pay for their health insurance benefits
with their pretax income.
- Health savings account (HSA)
- Flexible spending accounts (FSA)
- Dependent care assistance plan (DCAP)
- Retirement plans
Who is entitled to a cafeteria plan?
- Current employees, their spouses and dependents
- Former employees are also eligible but the plan CANNOT exist primarily for them.
What is a flexible spending arrangement?
- Type of cafeteria plan funded by salary reduction
- The plan reimburses employees for expenses incurred for certain qualified benefits
(dependent care assistance, adoption assistance, and medical care reimbursements)
- The maximum amount of reimbursement must be less than 500% of the actual amount
of the value of the coverage.
How do employers administer a cafeteria plan?
- Employees MUST agree to contribute a portion of their salary to the benefit plan on a
pre-tax basis.
- Since it is a salary deduction, the employee does not actually receive the deduction.
Therefore, the salary deduction is NOT part of gross wages for federal income tax
purposes.
- The salary deductions are also NOT subject to FICA and FUTA.
How does an employee report dependent care assistance of >= USD 5,000 on their W-2?
- An employee can exclude from gross income up to $5,000 of benefits received under a dependent care assistance program annually.
- It is reduced to $ 2,500 for married couples filing separately.
- The exclusion CANNOT be more than the annual earned income of the employee or the employee’s spouse.
- The total dependent care benefits that the employer provided (less than USD 5,000)
should be reported in Box 10 of W-2.
- Any amount over $5,000 should be included in Boxes 1, 3, and 5, as “wages,”
“social security wages” and “Medicare wages.”
- Employees are NOT allowed for advanced reimbursements for medical expenses.
What salary under a cafeteria plan is not subject to FICA, FUTA, Medicare tax or income tax withholding?
- Qualified benefits under a cafeteria plan are NOT subject to taxes mentioned above.
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EXCEPT for the following:
​
1. Group Life Insurance exceeding $ 50, 000 - it is now subject to ONLY social security
and medicare taxes, but not FUTA or income tax withholding.
2. Adoption Assistance Benefits- it is now subject to ONLY social security,
Medicare, and FUTA taxes, but not income tax withholding.
Other Key Details:
- Employers are NOT required to file form 5500 or Schedule F IF they only have a
cafeteria plan.
- Employes may be required to file if they hold a welfare plan.
- If an employee opts to receive cash instead of any qualified benefit, it is treated as
wages subject to all employment taxes.
- Domestic partners and dependents of employees are NOT ELIGIBLE for cafeteria
plans but may receive benefits depending on the employee’s selection of family medical
insurance coverage or of coverage under a dependent care assistance program.
- With a section 125 plan, employers can reduce tax liabilities.
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