What is a Section 125 Cafeteria Plan?
A Section 125 Cafeteria Plan is a type of employee benefit plan that is designed to take advantage of Section 125 of the Internal Revenue Code. Its name comes from the earliest such plans that allowed employees to choose between different types of benefits, similar to the ability of a customer to choose among available items in a cafeteria.
A Section 125 Cafeteria Plan allows employees to contribute a certain amount of their gross income to a designated account or accounts before taxes are calculated. The accounts are used to pay certain qualified benefit expenses of the employees (such as health insurance premiums) on a pre-tax basis, thereby reducing their total taxable income and increasing their take-home income.
By reducing employees' gross income, a Section 125 Cafeteria Plan also reduces the amount the employer pays in Federal Insurance Contributions Act (FICA or Social Security), Federal Unemployment Tax Act (FUTA), Workers' Compensation and some state taxes.
What are qualified benefit expenses under a Section 125 Cafeteria Plan?
Qualified expenses include but are not limited to:
• Health insurance premiums
• 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
• Voluntary "supplemental" insurance (dental, vision, cancer, hospital confinement, accident, etc.)
For more information regarding expenses that qualify for a Section 125 Cafeteria Plan, consult with a commercial insurance specialist from Alliance Insurance Agency Services, Inc.
How does a Section 125 Cafeteria Plan plan work?
Employer contributions to the cafeteria plan are usually made pursuant to salary reduction agreements between the employer and the employee in which the employee agrees to contribute a portion of his or her salary on a pre-tax basis to pay for the qualified benefits. Salary reduction contributions are not actually received by the participating employee. Therefore, those contributions are not considered wages for federal income tax purposes.
Who may receive benefits under a Section 125 Cafeteria Plan?
The plan may make benefits available to employees, their spouses and dependents. It may also include coverage of former employees, but cannot exist primarily for them. While sole proprietors cannot directly participate in the plan, they may legitimately employ their spouse and offer the spouse the benefits of the plan as long as the plan is offered on a non-discriminatory basis.
In regards to Section 125 Cafeteria Plans, non-discriminatory basis refers to making the benefits available to all eligible employees under the same terms, and that the plan does not favor highly compensated employees, officers or owners. The employed spouse may be considered a highly compensated employee and as such their contributions to the plan may be limited to the same terms as all eligible employees.
A partnership operates much like a sole proprietorship. While the partners cannot directly participate, they may employ a spouse who in turn may receive benefits. The same non-discriminatory rules apply to spouses of partners as it does to the spouse of a sole proprietorship.
For more information about Section 125 Cafeteria Plans for your business and employees, consult with a commercial insurance specialist from Alliance Insurance Agency Services, Inc.