Section 125 Cafeteria Plans: Tax Savings for Employers & Employees

If you're paying for employee benefits with after-tax dollars, you're essentially throwing money away. Section 125 cafeteria plans—also called "pre-tax benefit plans"—allow both you and your employees to save on taxes while providing valuable benefits. For Long Island business owners, these plans are one of the most overlooked opportunities to reduce costs and boost employee satisfaction.

What Is a Section 125 Cafeteria Plan?

Think of a Section 125 plan as a special account that lets employees pay for certain benefits with pre-tax dollars instead of after-tax dollars. It's called a "cafeteria plan" because employees can choose from a menu of qualified benefits, just like selecting items from a cafeteria.

The "Section 125" name comes from the IRS tax code that allows this arrangement. Without this plan, employees pay for benefits like health insurance premiums with money that's already been taxed. With Section 125, that same money comes out of their paycheck before taxes are calculated, reducing their taxable income.

How Section 125 Plans Work

Here's the step-by-step process: First, your company establishes a written Section 125 plan document that outlines which benefits are available and how the plan operates. Employees then elect to participate during open enrollment or when they're first hired.

When an employee chooses to participate, their selected benefit costs are deducted from their gross pay before federal, state, and FICA taxes are calculated. For example, if an employee earns $4,000 per month and pays $400 for health insurance through the Section 125 plan, they're only taxed on $3,600 instead of the full $4,000.

The most common benefits included in Section 125 plans are health insurance premiums, dental and vision insurance, flexible spending accounts (FSAs) for medical expenses, dependent care FSAs for childcare costs, and health savings account (HSA) contributions.

Why Smart Employers Offer Section 125 Plans

The primary business benefit is immediate payroll tax savings. As an employer, you pay FICA taxes on employee wages. When employees reduce their taxable wages through Section 125 deductions, your FICA tax burden decreases proportionally. This savings goes directly to your bottom line.

Beyond tax savings, these plans significantly improve your benefits package's value without increasing costs. Employees receive more take-home pay while getting the same benefits, making your compensation package more competitive for recruiting top talent in Nassau and Suffolk County's tight job market.

Section 125 plans also demonstrate that you understand and care about your employees' financial well-being. Professional service firms, medical practices, and accounting offices often find these plans particularly valuable because their employees typically have higher awareness of tax implications and appreciate sophisticated benefits.

What Employees Actually Get

From your employees' perspective, Section 125 plans deliver immediate, tangible savings. An employee in a 22% tax bracket saves 22 cents in federal taxes for every dollar they contribute, plus state taxes and FICA taxes. The total tax savings often range from 25-35% depending on their tax situation.

For employees with families, the savings can be substantial. Consider a dental office employee paying for family health coverage, contributing to a medical FSA for out-of-pocket expenses, and using a dependent care FSA for after-school care. The annual tax savings could easily amount to hundreds or thousands of dollars.

Flexible Spending Accounts deserve special attention because they're particularly valuable for your employees. Medical FSAs let employees set aside pre-tax money for expenses like deductibles, copays, and prescription medications. Dependent Care FSAs help working parents pay for childcare with pre-tax dollars. These accounts make budgeting easier while providing significant tax relief.

Key Considerations for Implementation

Section 125 plans require formal written plan documents that comply with IRS regulations. These documents must specify eligibility requirements, available benefits, election procedures, and administrative details. The complexity varies depending on which benefits you include and your company size.

Timing matters significantly. Employees generally can only make benefit elections during open enrollment periods or qualifying life events like marriage, divorce, or birth of a child. This "use it or lose it" rule for FSAs means employees must carefully estimate their annual expenses.

Administrative responsibilities include tracking employee elections, ensuring proper payroll deductions, maintaining compliance with nondiscrimination testing, and providing required employee communications. Many Long Island businesses find that professional plan administration eliminates the complexity while ensuring compliance.

How Benton Oakfield Simplifies Section 125 Plans

At Benton Oakfield, we handle every aspect of Section 125 plan implementation and administration for Long Island businesses. We draft compliant plan documents, conduct required nondiscrimination testing, manage employee communications, and coordinate with your payroll provider to ensure seamless operation.

More importantly, we educate your employees about how these benefits work and help them make informed decisions during enrollment. Many employees don't understand pre-tax benefits, which means they don't appreciate this valuable benefit you're providing. Our employee education ensures your team understands and maximizes their tax savings.

We also provide ongoing support throughout the year, handling FSA claim administration, managing qualifying life event changes, and ensuring your plan stays compliant with evolving regulations.

Ready to start saving money while improving your benefits package? Contact us today to learn how a Section 125 cafeteria plan can benefit your Long Island business and employees.

Compliance Note: Benefit plan rules and tax implications vary based on company size and location. This guide is for educational purposes only. Please contact your Benton Oakfield representative to discuss how this applies to your specific situation.

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