Can Employers Save Taxes with a Section 125 Cafeteria Plan?
The short answer is “yes, generally.” But let’s take a look at what a Section 125 cafeteria plan is.
A cafeteria plan provides an array of voluntary fringe benefits, allowing an employee to choose the ones that best fit their individual needs. The employee then elects to have monthly premium costs deducted from his or her paycheck and the employer forwards these premiums each month to the benefits company.
The plans are named for the section of the Internal Revenue Code that allows employers to withhold these premiums from employees’ pay on a pre-tax basis. Taxes generally saved include Social Security and Medicare contributions as well as Federal and State income taxes. The result is that employees are able to effectively buy these benefits at a discount – and are more likely to get the benefits they need to protect themselves and their families than if they had to purchase them on their own.
The employer benefits, too, because any premiums they withhold from employee paychecks are not subject to Social Security and Medicare tax.
Premium Only Plans (POP)
In this simple form of Section 125, the employer reconfigures existing plans into a Cafeteria Plan – thus using tax savings from the reduction in payroll taxes to offset a portion of premiums the company may already be paying on the employee’s behalf. These plans allow employers to mitigate increasing health insurance premium costs – with minimal administrative headaches.
Flexible Spending Accounts (FSA)
These popular benefits – authorized by IRC Section 105 and 106, allow employees to “set aside” money each pay check to spend on health care expenses. Benefits are tax free, and there is no payroll tax due on employee contributions to FSAs from either the employer or the employee. Once the plan is set up, these plans represent almost pure savings for the employer: The more employees that participate in FSAs, and the higher their contributions, the lower the employer’s ultimate payroll tax bill will be.
Dependent Care Expense Plans (DCE)
These plans are structured similarly to FSAs except that employees set aside contributions of up to $5,000 per year towards qualified dependent care costs. These costs can include child care or day care for children under 13, day care for elderly dependents, or care for a disabled spouse or other dependent. Employees ultimately save between 20 and 40 percent on these needed services.
If you have an ongoing 7.65 percent payroll tax on an employee who contributes the full $5,000, you, as the employer save $382 per year per participating employee from a DCE plan alone.
HDHPs/Health Savings Accounts (HSA)
High Deductible Health Plan/Health Savings Account combinations are a proven way to reduce health insurance premiums. They also dovetail nicely with Section 125 plans, since it is easy for employees to route their HSA contributions through the Section 125 program, increasing the efficiency of the overall plan, and saving additional dollars off of the employer’s payroll tax bill.