Under Section 125, the Internal Revenue Code offers employees several potential tax benefits. Employees are only able to take advantage of these benefits, however, if their employer participates in an eligible program. Through a Section 125 Cafeteria Plan, employers can provide employees with eligible programs.
A Section 125 Cafeteria Plan is an employee benefit plan that meets the requirements of Section 125 of the Internal Revenue Code. A Cafeteria Plan lets employees receive certain tax benefits. Specifically, employees are able to use a plan to pay for approved expenses with pre-tax dollars, thus saving them from paying taxes on the money put into their Cafeteria Plan. These plans are sometimes referred to as Section 125 Plans or Cafeteria Plans.
A Cafeteria Plan may provide employees with one or more of the following qualified programs:
Notably, there isn’t a program specifically for long-term care. Employees who face long-term care expenses can direct payments for services through a health savings account offered within a Cafeteria Plan, though.
Since the programs offered through Cafeteria Plans effectively reduce employees’ gross incomes, how much they save by participating in these programs will largely depend on their tax bracket. An employee in the 10-percent income tax bracket can save 10 cents on every dollar they direct to a Cafeteria Plan program. Someone who is in the highest bracket can save 39.6 cents for every dollar.
Employees’ savings will also depend on how much they put into these programs. Section 125 stipulates that the programs offered through a Cafeteria Plan must be optional programs. Thus, it’s up to employees how much they want to take advantage of the tax benefits that these programs offer.
The tax advantages that Cafeteria Plans offer also are beneficial for employers. Employers are able to realize savings on FICA withholdings (which often appear as Social Security and Medicare withholdings). At the time of writing, the current tax rate for Social Security was 6.2 percent for the employer, and the rate for Medicare was 1.45 percent, for a combined FICA tax rate of 7.65 percent. Employers can generally expect to save this much on any contributions employees make to plan programs.
In some cases, the FICA savings that businesses realize by offering Cafeteria Plans balance out most of the administrative costs associated with these plans. Depending on a plan’s administrative costs and how much employees contribute to the programs offered, the net price of offering a plan may be negligible.
Of course, offering a Cafeteria Plan with programs that employees want also increases employee contentment. Programs help employees keep more of their income, effectively increasing their compensation package. This can lead to longer employee retention rates and help attract new employees.
Employee benefits managers and administrators can help businesses set up a Section 125 Cafeteria Plan. They can both explain the options available to businesses and help businesses select the programs they want to offer. The expertise of an attorney who is familiar with benefits plans is sometimes required to ensure all the legally required paperwork is in order.