Section 125 plans are often referred to as cafeteria plans. These plans are referred to this way because participants can pick and choose or elect which, if any, benefits they would like to receive on a pre-tax basis.
Participants in a cafeteria plan must be permitted to choose from a minimum of two or more benefits:
Specifically, a cafeteria plan is defined as a separate written plan maintained by employers for employees that meets the specific requirements and regulations of Section 125 of the Internal Revenue Code (see Fringe Benefits section of Publication 15-B) The written Section 125 plan must be intended to be a permanent plan and specifically describe all benefits while establishing rules for eligibility and elections.
As an employer, cafeteria plans allow you to give employees access to a flexible benefits program that allows them to make benefit elections that meet their specific needs. The choice is made between taxable and non-taxable qualified benefits.
Qualified benefits include:
There are also a number of fringe benefits that cannot be included in a Section 125 cafeteria plan. These benefits include:
A Section 125 plan is the only means by which you can offer employees a choice between taxable and nontaxable benefits without the choice causing the benefits to become taxable. A Section 125 plan typically prohibits the deferral of compensation. However, there are four exceptions to this general rule:
Payroll is likely to be involved to some extent with regard to the funding of Section 125 plans. These plans can be funded in a number of ways. So-called flex dollars are funded by your contributions as an employer. Each employee is provided a certain number of flex dollars that he or she can use to buy selections from the plan or choose to receive as cash. Employees can use part of their salary to purchase benefit selections through either pre-tax or after-tax deductions, which typically results in a larger amount of take-home pay. Some regulations that are still in the proposal stage allow Section 125 plans to offer after-tax contributions for qualified benefits.
When running payroll, a qualified benefit's value is not included in an employee's gross income. However, when cash is the chosen benefit, it is to be included as part of the employee's income.
Ultimately, cafeteria plans are beneficial to both employees and employers. The amount of wage reduction resulting from cafeteria plan elections is not subject to Social Security and Medicare taxes. As a result, it also reduces the employer's share of these taxes. Also, the wage reduction is not subject to Federal Unemployment Tax Act (FUTA) taxes. On the other hand, prohibited benefits that are part of a cafeteria plan are taxable.
This content is for educational purposes only, is not intended to provide specific legal advice, and should not be used as a substitute for the legal advice of a qualified attorney or other professional. The information may not reflect the most current legal developments, may be changed without notice and is not guaranteed to be complete, correct, or up to date
