Employee Benefits: Section 125 Cafeteria Plans

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Employing talented individuals is an essential initiative of all business owners. Once hired, retaining top-notch talent becomes an equally important objective, as these performers have ample opportunities to utilize their skills in any number of ways for any number of organizations.  Workforce turnover is costly, and losing key employees can be detrimental to a business.  In no particular order, it is my opinion that motivated staff demand the following opportunities from their employers:

  • Challenging work environment,
  • Potential to serve others and make a positive impact in people’s lives,
  • Adequate compensation,
  • Potential to advance within an organization, and
  • Acknowledgment for their contributions.

When it comes to adequate compensation, cash wages comprise only a piece of the puzzle. Fringe benefits, such as health insurance and retirement plans, are equally important pieces of a balanced compensation package.  Since business owners have a vested interest in the well-being of their team members, offering health insurance as a component of employee compensation makes good sense.  Many employers have the opportunity to sweeten the deal by providing this benefit as part of a “cafeteria plan” under section 125 of the Internal Revenue Code (IRC).  The remainder of this post defines section 125 cafeteria plans, describes plan mechanics, and lists set-up requirements.

Defining Section 125 Cafeteria Plans. The Internal Revenue Service (IRS) defines a cafeteria plan as a separate written plan maintained by an employer for employees that meet specific requirements and regulations of section 125 of the IRC. Participants of an employer-sponsored plan can receive certain benefits on a pretax basis (i.e., free from income tax), and they must be permitted to choose among at least one taxable benefit (such as cash) and one qualified benefit (such as accident and health insurance).

Describing Cafeteria Plan Mechanics.  Section 125 cafeteria plans allow employees to contribute pre-tax dollars for payment of qualified benefits (i.e., accident and health insurance, dependent care assistance, group-term life insurance, etc.).  These contributions are generally made pursuant to salary redirection agreements between employer and employee.  Under such an agreement, salary redirection contributions are not actually or constructively received by the participant and, thus, are not considered wages for federal income tax purposes.  Furthermore, employee contributions to cafeteria plans are not subject to employment taxes (i.e., social security, medicare, and unemployment insurance).

Set-Up Requirements of Cafeteria Plans.  Business owners are required to execute the following documents in order to create section 125 cafeteria plans:

  • Plan Document, and
  • Adopting Resolution (if business is organized as a corporation).

In addition, employers must make the following documents available to eligible participants of the plan:

  • Summary Plan Description, and
  • Participant Forms, including
      • Election Not to Participate, and

     

  • Change in Status Election Form

 

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