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A Section 125 cafeteria plan is a benefits program that allows employees to pay for certain benefits using pre-tax payroll deductions. Because these contributions are deducted before taxes are applied, employees may reduce their taxable income.
Employers may also benefit from reduced payroll taxes. Cafeteria plans are commonly used to allow employees to pay for health insurance premiums and other eligible benefits on a pre-tax basis.
Several types of benefits can be offered through a cafeteria plan. Common examples include:
Employers must maintain written plan documents and ensure the plan complies with IRS nondiscrimination rules.
Pre-tax benefits allow employees to pay for certain benefits before taxes are deducted from their paychecks. This reduces employees’ taxable income, which can increase their take-home pay.
Employers may also benefit from lower payroll taxes because employee contributions made through pre-tax plans are not subject to certain payroll tax obligations.
Section 125 plans must meet nondiscrimination requirements established by the IRS. These rules are designed to ensure that benefit plans do not disproportionately favor highly compensated employees.
Employers typically perform annual nondiscrimination testing to confirm that the plan meets IRS requirements and that benefits are available fairly across the workforce.
Yes. Employers offering pre-tax benefits must maintain a formal written Section 125 plan document. The document outlines plan rules, eligibility requirements, and the types of benefits offered.
Without proper documentation, employee contributions may be treated as taxable income, which could create compliance and tax issues.
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