What a Section 125 Cafeteria Plan is and the pros and cons of it for Businesses (This page was updated on 12/18/2007)

If you have been contacted by someone who tried to charge you a large amount of money to set up a 125 Cafeteria plan ($500 or more as the cost can be as little as FREE to set it up), please contact us at by email. We are keeping track to make sure no one is being unfairly taken advantage by predatory sales people. The AF is in contact with the Attorney General's Office on this matter. All correspondence is kept confidential. email us at: feedback@healthcareforartists.org

The definition of a Section 125 Cafeteria plan or Section 125 Plan: "An employee benefit arrangement allowed by IRS Code Section 125, under which employees are allowed to pay for certain employee benefits on a pretax rather than an after-tax basis. Cafeteria plans, also known as Section 125 plans (because of the section of the IRS code that covers them), and flexible spending plans allow employees to use pretax dollars to choose among different types of benefits. Cafeteria plans typically have core benefits such as medical and life insurance, sick leave and sometimes disability benefits. Option benefits may include anything from dental insurance and elder care to vision coverage. They can't, however, include transportation assistance, tuition assistance or, unless part of a 401(k) plan, retirement benefits." Quoted from entrepreneur.com

The MA health care reform law has mandated that employers with 11 or more Full-Time-Equivalent Employees, to avoid being penalized under the health care reform law, are required to offer their full time employees and some of their part-time employees the option to participate in a 125 Cafeteria Plan to pay for their health care premiums.**

Section 125 Plans can be set up by: C Corporations, Partnerships, S Corporations, Limited Liability Corporations, Sole Proprietorships, Professional Corporations, and Non Profit Organizations. Even those businesses not mandated by the new health care reform law can set up a Section 125 Cafeteria plan. The self employed are not eligible, due to federal law, to participate in a Section 125 Cafeteria Plans (there are other exceptions and as soon as we get those in writing we will post them on this section). Please note that it should not cost an employer much money to set up a 125 Cafeteria Plan (well under $500 if not free if you follow the Connector's on-line guide).

The new law does not say that an employer, employee of a business, or an individual has to contribute to a Section 125 Cafeteria Plan. Those employees who decline to participate in Section 125 Plan will be required to sign a HIRD employee form. The 2007 HIRD employee form is now available. The Employee HIRD form is also available in Spanish and Portuguese.

So what does this actually mean? A Section 125 Cafeteria Plan reduces the amount of taxes both an employer and employee pays. It also reduces the employee's gross income. So let's say an employee is paid $1500 per month (pretax/ pre-withholding) at their job. Their health insurance premium through work is $300 per month and the employee puts that $300 dollars into a 125 Cafeteria Plan to pay for their premium. The taxable income for that month is reduced from $1500 to $1200 for both the employee and employer.

This also means as an employer you save on your payroll taxes if your employees do take advantage of a Section 125 Cafeteria Plan. By reducing an employee's gross pay, their employer pays less social security, Medicaid, worker's comp, and unemployment taxes for that worker. The employee saves on their income taxes and their take home pay may increased due to their gross income being decreased to a lower tax bracket, thus causing less taxes to be withheld. Short term this may seem like a great thing for the employee.

HOWEVER, there are some potential long term draw backs from an employee participating in a Section 125 Cafeteria Plan. By knocking an employee down to a lower tax bracket, it could potential hurt their future social security payments when they retire or partially retire. Remember by reducing their gross pay, both the employer and employee pay less social security tax. The employee, however, did not work less or earn less in reality, but by "accounting magic" you reduced their so called gross income, both of your tax burdens, AND both of your social security payments. This is very important for low income workers, the self-employed who have other part time jobs to make ends meet, and those workers who do not have retirement plans to understand. Also your employee's potential worker's comp and unemployment benefits will be reduced by utilizing a Section 125 Cafeteria Plan, as they too are based on what they have earned in their gross income.

On the Connector's website they have posted a Section 125 Plan Tools & Resources for employers.

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**full time workers (those who work 35 hours or more per week) under the law, must be offered to participate in a Section 125 Cafeteria Plan by their employer, BUT only part time workers who work an average of 64 hours per month will be eligible to participate in a Section 125 Cafeteria Plan. This must be done in order for the employer not to be fined/penalized by the state.

Employers may specifically exclude the following "employees" from participating in a Section 125 Cafeteria Plan: a) Employees who are less than 18 years of age, b) Temporary Employees (an individual who works on either a full or part time basis;whose employment is explicitly temporary in nature and does not exceed 12 consecutive weeks), c) Part-time Employees working on average, fewer than 64 hours per month for an Employer, d) Employees who are considered wait staff, service employees or service bartenders (as defined by in M.G.L. c. 149, section 152A) and who earn, on average, less than $400 in monthly payroll wages, e) Student Employees who are employed as interns or as cooperative students, f) Employees whose employer is required to contribute to a multi-employer Health Benefit Plan based on their employment, and g) Seasonal Employees who are international workers with either a U.S. J-1 student visa, or a a US H2B visa and who are also enrolled in travel health insurance.