Pre-Taxing Employee Benefits with a “Cafeteria Plan”

Section 125 of the Tax Code (Internal Revenue Code or IRC) is often called a “cafeteria plan”. It allows employees to pay for qualified benefits with pre-tax dollars. It is an advantage to employers because those dollars bypass FICA, FUTA, and Medicare taxes for both the employer and employee. Section 125 first appeared in the Tax Code back in 1975, but most employers only began taking advantage of it in 1986, when laws for deducting personal medical expenses changed. In this post, I will describe how an employer can take advantage of Section 125 through a cafeteria plan (also known as a Section 125 plan).

First, one of the requirements of Section 125 is that you have a plan document. This is very important, because in the event of an IRS audit you must produce a plan document. Dyste Williams can assist you with preparing the correct document.

A simple cafeteria plan to create, and low maintenance once established, is a Premium Only Plan (POP). This document gives the employer the ability to pre-tax their employees’ contributions towards health insurance, dental insurance, life insurance (capped at $50,000), disability insurance, and other voluntary types of benefits.

An employer can also establish a cafeteria plan with a FSA or HSA module. Choosing which module is appropriate for your organization depends upon the type of health plan you have in place. Only certain health plans qualify as Health Savings Account (HSA) compatible. These plans must have a high deductible, and cannot pay for any expenses, other than required preventative care, prior to meeting the deductible. Flexible Spending Accounts (FSA) are appropriate for plans that have deductibles and co-payments. These plans can also include a childcare account that allows parents to pre-tax their childcare expenses up to the federal maximum ($5,000 currently).

If you have a large number of employees who use mass transit or pay for parking at your place of business, you might want to consider adding a Section 132 plan that allows your employees to pre-tax their costs associated with those expenses. We most often see this used for a business in an urban location.

If you have a rich benefit plan – like a zero deductible plan – and you could achieve premium savings by adding deductible or higher copayments, you might want to consider a Health Reimbursement Arrangement. Your employees could be concerned about bearing this increased risk, but you can alleviate those concerns by creating an HRA that will pay these expenses only if they are incurred. HRA’s can be very versatile: you can define amounts to be used for dental, vision, prescription drugs, etc., and be very specific in the limitations.

I can help determine which plan is right for your organization. Please contact me, Heidi Michaels, at 952-843-4441 or hmichaels@dystewilliams.com.