Introduction to Section 125 Plans

A Section 125 cafeteria plan allows employees to pay for eligible benefits with pre-tax dollars, reducing taxable income and providing significant payroll tax savings for employers. Properly setting up a Section 125 plan ensures compliance and maximizes benefits for both employers and employees. This guide walks through each step of the process, from understanding legal requirements to implementing a seamless, fully compliant plan.

Step 1: Understand the Basics of a Section 125 Plan

Before implementing a Section 125 plan, employers should understand how it works and the advantages it offers. These plans include premium-only plans (POP), flexible spending accounts (FSAs), and dependent care assistance programs (DCAPs), all of which provide tax savings.

For a detailed comparison between a Section 125 plan and other employer benefit options, refer to our article on Section 125 Cafeteria Plans vs. Traditional Health Benefits: What’s Best for Employers?

Step 2: Determine Eligibility and Plan Type

Not all employers or employees qualify for a Section 125 plan. To be eligible:

• Employers must be a corporation, partnership, LLC, government entity, or non-profit.
• Employees must be W-2 employees (not 1099 contractors).
• The plan must comply with IRS, ACA, and HIPAA regulations.

Different types of Section 125 plans include:

• Premium-Only Plans (POP) – Allow employees to pay for health insurance premiums pre-tax.
• Flexible Spending Accounts (FSAs) – Cover medical expenses and dependent care costs with pre-tax dollars.
• Full Cafeteria Plans – Offer a combination of pre-tax benefits.

For additional details on The Most Common Section 125 Plan Compliance Mistakes Employers Make, see our in-depth guide.

Step 3: Create a Written Plan Document

The IRS requires that all Section 125 plans have a formal written document outlining plan rules, eligibility, benefits, and administration. The document must include:

• A clear list of benefits offered under the plan.
• Eligibility requirements for employees.
• Contribution limits for FSAs and dependent care accounts.
• Compliance measures ensuring the plan meets IRS non-discrimination rules.

If a plan fails compliance tests, employers may face penalties. Learn more from the IRS Section 125 Guidelines.

Step 4: Choose a Plan Administrator

Managing a Section 125 plan involves detailed record-keeping, compliance monitoring, and reporting. Employers can choose between:

• Third-Party Administrators (TPAs) – Handle compliance, claims processing, and plan administration.
• In-House Management – Requires a dedicated HR team to manage documents and compliance.

For a breakdown of administration options, read Third-Party Administrator vs. In-House Administration: What’s Best for Your Section 125 Plan?

Step 5: Establish Enrollment and Payroll Integration

To ensure smooth operation, employers must:

• Educate employees about plan benefits and enrollment procedures.
• Integrate Section 125 deductions into payroll systems.
• Set up a compliance review process to monitor changes in tax laws.

Step 6: Maintain Ongoing Compliance and Reporting

Employers must comply with IRS non-discrimination tests, which ensure that highly compensated employees do not receive disproportionate tax advantages. Required annual tests include:

• Eligibility Test – Ensures fair access for all employees.
• Contributions and Benefits Test – Confirms benefits are distributed fairly.
• Key Employee Concentration Test – Limits benefits for key employees.

Failing compliance can lead to plan disqualification and tax penalties.

Get Started Today

Setting up a Section 125 plan can lead to significant payroll tax savings and improved employee benefits. To simplify the process, consider working with a fully managed Section 125 solution that eliminates compliance risks and administrative burdens.

Take the Next Step

• Find out if your company qualifies for a Section 125 plan.
• Learn how much your business could save with pre-tax benefits.
• Talk with an expert today to set up a compliant, fully managed plan.

Visit: www.elevate-benefits.com
Email: contact@elevate-benefits.com