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Section 125 plans—also known as cafeteria plans—are becoming more and more popular among American companies as a means of providing tax-advantaged perks to staff members and lowering payroll taxes. These plans let workers pre-tax pay for several perks such flexible spending accounts, dependent care, and health insurance premiums. These tax advantages, meanwhile, also with responsibility. Your Section 125 plan must follow particular legislative rules if you want to stay in good standing and avoid any IRS penalties.
How then can you find out if your Section 125 plan complies exactly with IRS rules? Let’s start with the basics.
A Section 125 Plan is what?
Under a Section 125 plan, workers may turn some of their taxable income into non-taxable benefits. Usually, these advantages consist:
Premiums in health insurance
Coverage for vision and dental work
Flexible spend accounts (FSAs) and health savings accounts (HSAs)
Help with dependant care
Offering these pre-tax benefits helps firms and workers save Medicare, Social Security, and federal income taxes. Employers have to satisfy IRS compliance criteria, though, if they are to keep these savings.
The Value of a Section 125 Plan Documenary
Every Section 125 plan must, according to the IRS, have a formal documented Section 125 plan document. The parameters, eligibility, incentives provided, and operating policies of the plan are described in this paper.
Whether your Section 125 plan is compliant in practice or not depends on a well written, current plan document. This might mean that, during an audit, all tax benefits are denied, maybe costing thousands in back taxes, interest, and penalties.
Important components your Section 125 plan document must include are:
An account of every advantage provided
Conditions of eligibility for involvement
Election policies and intervals
Guidelines for midyear revisions
Claims and refund handling policies
To be compliant, companies also have to update the plan document for any operational changes, regulatory changes, or benefit enhancements.
Typical Compliance Problems
Many companies believe incorrectly that their insurance companies or benefit providers handle all compliance issues. Actually, the company bears final responsibility for making sure the plan is legal. Some such errors are listed here:
Missing or obsolete plan documents: Should your plan document not have been updated in the past few years, it might not represent current IRS rule changes.
Providing ineligible benefits: A Section 125 plan cannot cover every benefit. Including ineligible choices can throw off the strategy.
Employees can only modify their elections during designated times unless they go through a qualified life event.
Failing nondiscrimination rules: Section 125 plans have to be tested annually to make sure they do not unfairly benefit highly paid workers.
Techniques to Guarantee Compliance
Here are some actions to do if you’re not sure whether your Section 125 plan complies:
Review your Section 125 plan yearly. Make sure it follows the most recent IRS rules and fairly presents your present offerings.
Every year, do necessary nondiscrimination tests to prevent compliance issues that can compromise the tax situation of your plan.
Teach your HR staff acceptable benefit elections and adjustments. Non-compliant behavior might result from misinterpretation.
See a skilled ERISA attorney or benefits consultant to guarantee continuous compliance and get professional advice.
Though with those benefits come significant compliance obligations, Section 125 plans are a useful tool for lowering benefit expenses and improving employee satisfaction. Ignoring IRS laws or neglecting to keep a valid Section 125 plan document could have expensive results for your company and staff.
Not gamble on IRS fines. Verify that your Section 125 plan is supported by the correct documentation, current, and compliant.
