Pre Tax Plans (Section 125 Cafeteria Plans)

Kerr Payroll Solutions specializes in writing pre tax cafeteria plans. For a small fee we can help your business save big on taxes with a section 125 pre tax plan. 

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Taxes are part of the cost of running a business and hiring employees. A pre tax plan can help save on FICA, federal and state and local taxes. By combining a section 125 premium only plan (POP) and flexible spending account (FSA) with your companies group health or certain voluntary insurance.

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What is a cafeteria plan?

A cafeteria plan is a separate written plan maintained by an employer for employees that meets the specific requirements of and regulations of section 125 of the Internal Revenue Code. It provides participants an opportunity to receive certain benefits on a pretax basis. Participants in a cafeteria plan must be permitted to choose among at least one taxable benefit (such as cash) and one qualified benefit.

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A qualified benefit is a benefit that does not defer compensation and is excludable from an employee’s gross income under a specific provision of the Code, without being subject to the principles of constructive receipt. Qualified benefits include the following:

• 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

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The written plan must specifically describe all benefits and establish rules for eligibility and elections.

A section 125 plan is the only means by which an employer can offer employees a choice between taxable and nontaxable benefits without the choice causing the benefits to become taxable. A plan offering only a choice between taxable benefits is not a section 125 plan.

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How does a cafeteria 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 or constructively received by the participant. Therefore, those contributions are not considered wages for federal income tax purposes. In addition, those sums generally are not subject to FICA and FUTA. See Sections 3121(a)(5)(G) and 3306(b)(5)(G) of the Internal Revenue Code.

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The above discussion provides only the most basic rules governing a cafeteria plan. For a complete understanding of the rules, see the Proposed Regulations under IRS Code section 125.

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What is a flexible spending arrangement?

A flexible spending arrangement (FSA) is a form of cafeteria plan benefit, funded by salary reduction, that reimburses employees for expenses incurred for certain qualified benefits. An FSA may be offered for dependent care assistance, adoption assistance, and medical care reimbursements.  The benefits are subject to an annual maximum and are subject to an annual “use-or-lose” rule. The maximum amount of reimbursement which is reasonably available to a participant for such coverage must be less than 500 percent of the value of the coverage. In the case of an insured plan, the maximum amount reasonably available must be determined on the basis of the underlying coverage. An FSA cannot provide a cumulative benefit to the employee beyond the plan year.

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