What is a Section 125 Cafeteria Plan?
One of the most underrated and underused benefits available for small businesses today is outlined in section 125 of the U.S. tax code. A section 125 or "cafeteria" plan allows employees to withhold a portion of their pre-tax salary to cover certain medical or child-care expenses. Because these benefits are free from federal and state income taxes, an employee's taxable income is reduced, which increases the percentage of their take-home pay. And because the pre-tax benefits aren't subject to federal social security withholding taxes, employers win by not having to pay FICA--or workers' comp premiums--on those dollars.
Under a cafeteria plan, your employees can take advantage of
three specific flexible benefits:
1. Pre-tax health insurance premium deductions, also known as a Premium Only
Plan (POP). POP plans allow employees to elect to withhold a portion of
their pre-tax salary to pay for their premium contribution for most
employer-sponsored health and welfare benefit plans. The plan offers a simple
way to obtain favorable tax treatment for benefits already offered. Most
companies currently have this set up through their payroll provider. A POP plan
is the simplest type of Section 125 plan and requires little maintenance once
it's been set up through your payroll.
2. Out-of-pocket unreimbursed medical expenses, also known as flexible
spending accounts (FSAs). An FSA allows an employee to fund certain medical
expenses on a pre-taxed basis through salary reduction to pay for out-of-pocket
expenses that aren't covered by insurance (for example, annual deductibles,
office co-payments, prescriptions, over-the-counter drugs and orthodontia). The
average working employee in America spends more than $1,000 annually on these
types of benefits. By participating in a FSA, an employee's taxable income is
reduced, which increases the percentage of pay they take home.
3. Dependent care flexible spending accounts. The dependent care FSA is an attractive benefit for employees who pay for child-care or long-term care for their parents. Many employees don't take advantage of this benefit and may be unaware of the significant tax savings. Employees may hold back as much as $5,000 annually of their pre-tax salary for dependent care expenses, which include expenses they pay while they work, look for work or attend school full time. Qualified dependent care expenses may include--but are not limited to--the care of a child under the age of 13, long-term care for parents, care for a disabled spouse or a dependent incapable of caring for himself, and summer day camps. In addition, by paying for dependent care with pre-tax dollars, your employees can save approximately 20 to 40 percent on their child-care expenses.
The best part about the Section 125 plan is that most of your employees are
already paying for these expenses out of their own pockets with after-tax
dollars. Cafeteria plans offer them a remarkable way to save money they're
already spending.