An employer-sponsored benefit plan under IRS Section 125 that lets employees choose to pay for qualified benefits with pre-tax dollars, reducing taxable wages and lowering FICA for both the employee and employer.
Why a cafeteria plan matters for employers
A Section 125 cafeteria plan is one of the most valuable payroll tax reduction tools available to employers of any size. Under a qualifying plan, employees elect to receive certain benefits instead of cash, reducing their taxable wages. Because the benefit is paid pre-tax, neither the employee nor the employer pays FICA on those dollars. The most common qualifying benefits are employee premiums for health, dental, and vision insurance; Health Savings Account contributions (when paired with a high-deductible health plan); Flexible Spending Account contributions for health care and dependent care; and group term life insurance premiums up to $50,000 in coverage. To qualify under Section 125, the plan must be in writing, must offer employees a choice between cash and qualified benefits, and must pass IRS nondiscrimination tests ensuring the plan does not disproportionately benefit highly compensated employees or key employees. For a concrete example of the savings: if an employer has 50 employees each paying $300 per month in health insurance premiums through a Section 125 plan, the employer saves the 7.65% employer FICA match on $180,000 per year in pre-tax employee contributions, which is $13,770 annually. Employees save the 7.65% employee FICA share on their own contributions. Both savings occur automatically with no additional cost, simply by having the plan document in place and collecting elections annually.
How BEG handles Cafeteria Plan (Section 125) for clients
BEG Managed Payroll processes Section 125 pre-tax benefit deductions correctly on every payroll run, ensuring they reduce Box 3 and Box 5 wages on the W-2 accurately. If your benefit deductions are not being taken pre-tax when they should be, BEG can identify and correct the setup during onboarding. Correct Section 125 processing is included in BEG Managed Payroll at $25-$45 per employee per month. Learn about BEG Managed Payroll.
Frequently asked questions
What benefits can be offered through a Section 125 plan?
Qualifying benefits include health, dental, and vision insurance premiums; Health Savings Account contributions; health and dependent care Flexible Spending Account contributions; and group term life insurance up to $50,000 in coverage. Cash or taxable benefits cannot be made pre-tax through Section 125.
Does a Section 125 plan require a written document?
Yes. IRS regulations require a written plan document. Without a written plan in place, benefits cannot be treated as pre-tax under Section 125, even if the employer and employee intend them to be.
What happens if the plan fails nondiscrimination testing?
If the plan fails the Section 125 nondiscrimination tests, highly compensated employees or key employees lose the pre-tax treatment for their benefits and must include the value of those benefits in taxable income. Non-highly-compensated employees are not affected.
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About the author
Anthony Moretti is VP of Sales at Business Executive Group, where he builds BEG's managed payroll and HR service verticals for employers across Dallas-Fort Worth and nationwide. He writes the BEG Payroll Glossary to give employers plain-English answers on payroll and compliance.
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