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IRS Section 125 Cafeteria Plans – How To Use Them

Health Savings Accounts

An IRS Section 125 Cafeteria Plan is a plan established by an employer that allows his employees to contribute a portion of their salary each month, income tax–free to them and salary tax–free to their employer. Qualified benefits are paid for with pre–tax dollars that would otherwise be paid for with after tax dollars. The name Cafeteria refers to the fact that there are three different benefits which can be chosen to be included in an employer’s plan. The three benefits include a 125 Premium Only Plan (POP), a Flexible Spending Account (FSA) and a Dependent Day Care (DDC) benefit.

We offer small employer health insurance plans in the following states:
Oregon - Washington
Where To Go Next

The Third Party Administrator

Medical and Dental Expenses

See Also


Four Categories of Expenses Covered as FSA Eligible

  1. That portion of an employee's health insurance premiums paid for by the employee each month.
  2. Other health related premiums paid by the employee such as vision coverage, dental insurance, a supplemental disability or accident policy offered through the employer.
  3. Health care related expenses that are not reimbursed by the group health insurance plan.
  4. Dependent day care expenses for children.

Plan May be Established as a Premium Only Plan or POP

A Premium Only Plan (POP) can be established for categories 1 and 2 above covering that portion of group health insurance premiums paid by the employee and premiums on any other qualifying supplemental insurance policies offered through the employer on a payroll deduction basis. Including categories 3 and 4 involves the establishment of a special trust account for employee funds and invokes the use-it-or-use-it-provision below.

Employer Sponsored Special Health Care Spending Account

A Flexible Spending Account, or FSA, is an account established by an employer that allows his employees to contribute a portion of their salary each month, income tax–free to them and salary tax–free to their employer, for the purpose of paying for their health care expenses. It is not available for self–employed individuals or individual employees on their own. Congress authorized the FSA under the Revenue Act of 1978 and the FSA is subject to IRS regulations and guidelines. It is sometimes referred to as a Section 125 plan after the IRC section number. Any health insurance policy approved as an employee benefit plan can be used in conjunction with an FSA plan.

Dependent Dare Care Expenses Can Be Part of an FSA

Dependent day care expenses for children can also be included in the FSA plan design.

Annual Election and Dollar Commitment with a Use-It-or-Lose-It Provision

At the annual plan renewal date, each employee must decide whether he or she wants to participate in the plan for the coming year. An employee who decides to participate must also decide how much is to be withheld from his or her paycheck each month. This, at best, is an educated guess as to how much of the deductible and coinsurance amounts might be required, what other qualifying expenses such as dental and vision will be used, and what dependent day care costs will be. This amount cannot be changed during the year except for certain qualifying events. Any funds left in an employees' account 2 1/2 months after the end of the year are lost* and belong to the employer. The employer can only use those funds for the benefit of all employees, as would be the case for an office party or dinner for all employees. * NEW - IRS Notice 2005-42

Employees Save on Income Taxes Giving Them an Effective Pay Raise

An employee saves money by not having to pay income tax on the money withheld for the FSA. Let's say an employee is in the 30% tax bracket for payroll withholding tax purposes. That means the employee's paycheck would increase $30 for every $100 put in the FSA each month compared to spending the same $100 without an FSA plan in place. The $30 increase comes from savings on income taxes that would otherwise be paid.

Employers Save on Payroll Taxes by Reducing Taxable Payroll

An employer reduces his payroll for payroll tax purposes by the amount of employee contributions to the plan. This savings on FICA and FUTA taxes amounts to a 7.65% savings. The employer would reduce his tax bill by $76.50 for each $1,000 contributed to the plan by his employees.

Employers Must Meet Two Tests on a Yearly Basis

An employer must meet the Key Employee Concentration Test and the Highly Compensated Employee Average Benefit Test on a yearly basis. This is designed to prevent excessively benefiting a select few. A Third Part Administrator (TPA) usually handles these details.

We Offer Two Options

AFLAC provides "free" assistance in setting up premium only accounts and charges fees for administering an account that includes a fund requiring reimbursements. The term "free" is contingent on an AFLAC representative meeting with employees and placing at least three small supplemental policies in the group. Manley Services is a fee based Third Party Administrator (TPA) we work with because of their excellent service. There are others in Oregon to choose from.


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