What is a Section 125 Plan?

A Section 125 Plan is an insurance benefit plan that employers may offer under rules outlined in Section 125 of the IRS Code.  The major benefit of a Section 125 Plan is it allows employees to completely eliminate income taxes on three types of out-of-pocket expenses:  insurance premiums, medical/dental expenses and dependent care expenses.  Employers will also realize savings by reducing the tax liability on total payroll.

Saving money on taxes isn’t the only reason you should consider offering a Section 125 Plan to your employees:

• Your insurance programs become an even better value than they already are
• Your employees can increase their take-home pay (without a pay raise!)
• Positive impact on employee retention and morale
• Debit cards make paying for eligible expenses easy
• You can take credit for offering a new program while saving the company money
• If contribution increases become necessary, the impact is offset by tax savings

Many small employers take insurance premium and medical expense reimbursement deductions on a pre-tax basis, without the knowledge that a formal Plan Document and Summary Plan Description are required by the Internal Revenue Service Code.  The penalty for non-compliance may include disallowance of all deductions, payment of all delinquent taxes and IRS-imposed penalties and interest.

Premium Only Plan

A Premium Only Plan is a very basic plan option that employers may offer. It allows eligible employees to contribute to the cost of certain insurance coverages on a pre-tax basis. A premium-only plan provides no other benefits to employees.

Health Care Spending Account

Health Care Accounts allow employees to “set aside” money toward expected or pre-planned out-of-pocket medical and dental expenses, such as co-payments, deductibles, coinsurance and over-the-counter medications, and other expenses not traditionally covered by the group health insurance.  Qualified medical expenses are those that would generally qualify for the medical and dental expenses deduction. These are explained in IRS Publication 502, Medical and Dental Expenses (http://www.irs.gov/publications/p502/ix01.html).

An employee may not receive distributions from the FSA for the following expenses:

• Amounts paid for health insurance premiums
• Amounts paid for long-term care coverage or expenses
• Amounts that are covered under another health plan

Dependent Care Spending Account

Allows employees to pay for the care of a qualifying dependent with pre-tax dollars.  As an example, an employee in the 20% Federal tax bracket who pays $400/month for child care could save as much as $1,400 per year by participating in a Dependent Care Spending Account.

Under this plan, qualified dependents are children under age 13, a disabled spouse, or a disabled dependent regardless of age.  There are limits on the amount that can be withheld as well as other considerations that should be taken into account when deciding to participate in a Dependent Care Spending Account.  IRS Publication 503, Child and Dependent Care Expenses (http://www.irs.gov/publications/p503/ar02.html) provides examples of qualified and non-qualified expenses.

Setting up a Section 125 Cafeteria Plan is not as complicated or as expensive as you might think.  Give us a call today to find out if your company could benefit from implementing this program for your employees.