Section 125 (Cafeteria) Plans

Under a Section 125 Plan, the IRS allows employers to deduct an employee’s group insurance premium and FSA (flexible spending account) deductions on a pre‐tax basis. This means that the employee does not pay federal income tax or FICA tax (social security and Medicare) on these deductions. Employers benefit because they do not pay the matching FICA tax on the employee deductions.

Putting the Flexible Spending Account (FSA) Pieces Together

There are three components to an FSA plan, a health care FSA, dependent care FSA and the premium only plan (POP) component. Under the health or dependent care FSA, the employee has to make an annual pledge or election each year. The POP component of the plan is typically designed so that the employees are automatically enrolled to have their insurance premiums deducted pre‐tax.

Premium Only Plan (POP)

Just like it sounds, the POP just includes the employee portion of any eligible insurance premiums.  The POP component of the plan is typically designed so that the employees are automatically enrolled to have their insurance premiums deducted pre‐tax.

Health Care FSA (HCFSA)

The health care FSA is a pre‐funded arrangement that allows employees to set aside money from their paycheck for the reimbursement of out‐of‐pocket health care expenses. Qualified health care expenses are defined by IRS Section 213(d) and include almost all medical, dental, vision, Rx and over‐the‐counter expenses. Items and procedures that are cosmetic or for one’s general well‐being are not covered under the plan. As a pre‐funded arrangement, an employee has full access to their annual pledge on the first day of the plan year.

Day Care FSA (DCFSA)

Employees can set aside money from their paycheck for the reimbursement of their day care expenses for qualifying individuals. Unlike the health care FSA, the day care FSA is not a prefunded account, but more like a traditional bank account. The day care FSA has a set limit of $5,000 per taxable year and is an alternative to the child tax credit. Employees considering a day care FSA should consult a tax advisor to determine if it is a better option than the child tax credit. There are various online calculators that can help employees make this decision as well.

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