What is a Section 125 Plan?

  Known generically by many different names, such as Cafeteria Plan, Premium Only Plan, Salary Reduction Plan, Flexible Benefit Plan, and Premium Conversion Plan, they are operating under the provisions of Internal Revenue Code Section 125.  As to a technical point regarding proper nomenclature, a Cafeteria Plan is a broad name for a Section 125 Plan, under which all of these plan names fall.

  So what's the big deal about them?  Well, simply a Section 125 Plan permits employees to pay for qualified fringe benefits with pre-tax dollars that otherwise would have been paid for with after-tax dollars.  The employee makes an election to voluntarily reduce their gross taxable income by the amount of the benefit cost, which in turn, results in the employee paying fewer taxes, which in turn, results in a bigger net paycheck to the employee.  The employer also saves on payroll taxes because the salary reduction amount is not subject to employer Medicare and Social Security tax.

  What are the qualified fringe benefits?  There are really quite a few, but the most popular plans provide for medical insurance, uninsured medical expense costs (deductibles and uncovered medical), and dependent care.

  So what is the downside?  First, the plan cannot discriminate to favor key or higher compensated employees.  Second, the paperwork on setting up and the time to administer the plan.  Depending upon the number of participating employees, the administration of the plan could cost more than the benefit derived by the employer. But if a staff member could take over the task of administrating the plan, the overall benefit to the employee and the employer could be well worth the effort in the long run.

  If you have any questions on setting up or administrating a Section 125 Plan, please feel free to contact us.

Bruce Baer, CPA