A 125 cafeteria plan is a benefit plan that allows employees to withhold part of their pre-tax salaries to cover qualified expenses, reports Entrepreneur. Employers start them by establishing a plan document, distributing a summary plan description to all employees who participate and monitoring ongoing compliance with legal mandates.
Under a 125 cafeteria plan, an employer can set aside pre-tax income for expenses like health insurance premiums, out-of-pocket medical expenses, childcare, and long-term care for parents, a disabled spouse or other dependents, according to Entrepreneur. Deducting an amount of pre-tax income for the 125 cafeteria plan also lessens an employee's taxable take-home pay, so that employee pays lower taxes. Employees decide the amount to be deducted from their salaries based on the specific benefits they need, and the employer deducts the money throughout the plan year.
Employee contributions to 125 cafeteria plans are not subject to any taxation, including Social Security or Medicare taxes, so employers can offer a benefit program without having to make matching contributions, reports About.com. Employers also save on workers' compensation premiums, which are based on the taxable salaries of employees. Generally, there are no filing requirements for 125 cafeteria plans, states the IRS. The benefits are available to employees, spouses, dependents and, sometimes, former employees.