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November 7, 2019

Is Your Section 125 Plan Document Compliant?

A Section 125 Plan (aka cafeteria plan) allows employees to pay for health insurance, certain expenses and other eligible benefits with pre-tax dollars. Essentially, the employer offers employees the opportunity to agree to a salary deduction in exchange for the benefits. This reduces the employee’s taxable income, making their health insurance and other eligible benefits tax-favored. Employers save, too, by reducing the overall payroll base on which FICA and other payroll taxes are calculated.

As an employer, you must ensure that your Section 125 plan document is compliant with the latest requirements of the IRS.

Section 125 Plan Document Requirement

Every employer offering at least a tax-favored payroll deduction or medical, dental or other benefits must have an up to date plan document. IRS Code, Section 125 (d) (1), sets the Section 125 plan document requirement for employers offering the option of paying for health insurance and other benefits with a pre-tax salary deduction. Here is some basic information about the plan document:

  • A Section 125 plan document contains all information on the plan, including eligibility rules, benefits available, plan trustee(s) and administrator(s), and more, as needed, to properly describe the Section 125 plan in full.
  • The required plan document must be in place before the first day of the plan year when the benefits are available to employees.  
  • A copy of the Summary Plan Description (SPD) part of the plan must be distributed to every employee eligible to participate in the plan prior to the start of each plan year.
  • The Section 125 plan document requirement does not include filing the document with any government agency; however, it must be kept on file and available for employee requests or in the case of an audit.
  • The Section 125 plan document must be updated on an annual basis.
  • Nondiscrimination testing of the Section 125 plan document must be completed annually.

Nondiscrimination Testing

We draw special attention to the last point regarding non-discrimination testing. Section 125 plans must generally pass certain tests designed to ensure the plan does not discriminate in favor of highly compensated employees. If a plan fails to pass non-discrimination testing, highly compensated employees lose the tax-favored benefits of participating in the plan (that is, they must include the benefits or compensation in their income). However, even if a Section 125 plan is discriminatory, non-highly compensated employees will not lose the tax benefits of participating in the plan.

In general, a Section 125 plan must satisfy the following three nondiscrimination tests:

  • Eligibility test
  • Benefits and contributions test
  • Key employee concentration test

Staying Compliant

In order to be in compliance with laws governing pre-tax treatment of insurance premiums, your business must have a Section 125 plan document and annual testing in place, as defined by the code. There are many third-party administrators offering annual updates and testing for reasonable fees. A qualified benefit advisor with tax law expertise can guide you to resources compliant for the tax-advantaged treatment of employee group benefits. 

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