What Are IRS Section 125 Guidelines?

The Internal Revenue Service’s tax code 125 provides guidelines for employees to get access to qualified benefits that are exempt from federal or state income taxes, according to Core Documents. Also known as Section 125 Cafeteria Plans, they are the most underused benefits available for small businesses and taxpayers.

The qualified benefits permitted under Section 125 include medical, accident and disability benefits; group term life insurance; and dependent care assistance, notes Core Documents. The plan reduces an employee’s taxable income, thus reducing an employer’s tax liability and bringing down FICA tax payments. In some states, it reduces payments for workers’ compensation.

Section 125 guidelines can be used to set up two types of Cafeteria Plans: a premium only plan, or POP, or a flexible spending account, or FSA, reports Total Administrative Services Corporation. In the POP, a part of the company’s insurance premiums are directly deducted from an employee’s gross income before taxes. In the flexible spending account, employees put aside a predetermined amount of their pretax income for medical, dependent-care and other qualified expenses. The amount chosen as part of the FSA plan is not an arbitrary number. Employees should look at the expenses they expect to have in a year and choose an amount as close as possible to that amount, given that any funds remaining in the account at year’s end are forfeited to the employer.