Cafeteria Plans (Section 125 Plans) A Section 125 "Cafeteria" plan is an excellent way to save taxes for the employer as well as the employees. An employer must meet several strict regulations in order to comply with IRS and ERISA regulations regarding this tax qualified benefit plan.  In a quick overview, a 125 plan allows an employer to establish several pretax accounts for employees to use. There are three main types of accounts: Premium Only Plan (POP)- provides for pretax payment of medical premiums of a group medical plan. Medical Reimbursement - allows employees to set aside money from each paycheck to get reimbursed on a pretax basis for such things as deductibles, or dental or vision expenses. This is the use it or lose it portion. Anything that an employee does not use by the end of a calendar year is lost and reverts to the employer. The employer selects the maximum allowed.  Child Care Reimbursement - lets an employee set money aside from each paycheck to reimburse on a pretax basis child care expenses. This is capped at $5000 a year in total. The rest of this page is reference information that you can access from the left menu. The following checklist of documentation will be reviewed by the IRS if the plan is audited: Plan Document: A current signed plan document must be on file, including any plan amendments. Administer the plan according to the plan document. Discrepancies between the plan document and the plan in operation should be corrected whether by a plan amendment or a change in plan operation. Summary Plan Description: Your employees should be given a summary plan description (SPD) outlining the plan benefits and their rights under the plan. Contributions: Both elective (employer dollars) and non-elective (employee salary reduction) should be capped at a high enough amount so that all qualified premiums can be pre-taxed under the plan. Election Forms: Completed, signed election forms should be on file for all employees. Employees should sign either an election to participate or a waiver of participation when they are first eligible to participate. Often the plans are drafted saying that employees participate unless the employee chooses not to participate. This makes the plan easier to establish since the employees are in the plan unless they indicate in writing they choose not to. Other Documentation: Other documentation that should be kept on file include change in family status forms, FMLA and COBRA notices to employees. Also, keep proof when insurance rates increase or decrease and employee changes occur. ----------------------------------------- Go to top of page COBRA An employee has certain COBRA rights involving a medical reimbursement account. Money already in the account can still be used to reimburse expenses. New money can be contributed but not on a pre-tax basis since the person is no longer an employee receiving wages. Check with your COBRA administrator for details. Discrimination Testing: Maintain documentation showing that all required discrimination testing has been performed for the cafeteria plan. Compliance Issues: Maintain copies of all annual 5500 reports filed for the plan. A Form 5500 should be filed for each year that the plan is in existence. Every cafeteria plan MUST file a Form 5500. ----------------------------------------- Go to top of page Payroll Issues: Make sure that employee salary deferrals to the cafeteria plan are being treated correctly for tax purposes, i.e., plan contributions should not be subject to FICA, Federal or State taxes and Federal Unemployment; contributions may not be subject to some local taxes (check with the local government officials). A Cafeteria Plan allows participants to choose from a menu of two or more options which may include cash and the following five benefits, which IRS allows to be excluded from wages: Group-term life insurance Accident or health insurance (including employee paid disability income) Participation in a 401(k) retirement plan Dependent care assistance program Group legal services plan -(was not renewed and is no longer eligible for the list) The key definition is that the premiums must be payable on a payroll deduction basis at the employer. For example: an individual medical plan paid directly by the employee is was not eligible to be paid on a pre-tax basis because it is not payroll deducted at the employer. You can set up a special POP plan to allow pre-tax individual medical insurance now. In Minnesota, individual medical insurance wasn't allowed to be sponsored by an employer. This has changed recently and you can "sponsor" Individual medical as an employer. Same thing applies to disability income insurance unless it is a pay roll deduction plan sponsored by the employer. (If disability income premiums are pre-tax, then the monthly benefits would be taxable.) ----------------------------------------- Go to top of page Premium Only Plans (POP) Cafeteria plans come in three parts. Part one is the "Premium Only Plans" (POP), part two is "Medical Reimbursement", and part three is "Child Care Reimbursement." An employer can elect the POP part as a stand alone. The POP plan,  established by an employer, allows employees to pay medical premiums pre-tax (as well as other qualifying premiums. See the list for what qualifies.) Optionally there are other additions for the POP such as employee payroll deductions for contributions to a Health Savings Account. An employer can also offer a premium reimbursement account for individual medical premiums that are not group premiums. ----------------------------------------- Go to top of page Who should administer a 125/cafeteria Plan? An employer can self administer a Cafeteria Plan. There are no rules to the contrary. However, a third party firm that specializes in Cafeteria Administration can be a better choice. The nominal cost of administering, reimbursing employees, and discrimination testing charged by firms that specialize in Cafeteria Plans more than justify having an a third party administer it than over paying an employee do that for a business. Premium Only Plans, even though simple to install, still require discrimination testing annually. Even though this calculation is not difficult, who would do that internally at your company? Some accounting firms and/or payroll firms offer the service. If you would like a more information or to obtain 125 Documents, click here