A cafeteria plan provides employees an opportunity to receive certain benefits without being taxed by the federal government, explains the Internal Revenue Service. Taxes on these expenses are exempt by section 125 of the Internal Revenue Code. A cafeteria plan can also include expenses for dependent care, adoption and life insurance.
An employer can design a cafeteria plan that meets the requirements of section 125. Employees, their spouses and dependents can receive qualified benefits under such a plan. Accident and health benefits, adoption assistance, dependent care assistance, group-term life insurance coverage and health savings accounts are qualified benefits, according to the IRS.
The employer makes a contribution to the cafeteria plan of behalf of an employee after deducting the amount from the employee's gross pay, notes the IRS. These contributions are used to provide the benefits and not actually received by the employee. Hence, they are excluded from federal income taxes and Social Security taxes. In a flexible spending arrangement, or FSA, which is a form of cafeteria plan, the section 125 rules are satisfied by the "use-or-lose" rule. The employee agrees to contribute an amount subject to an annual maximum. The use-or-lose rule means this amount can only be used for qualified benefits and only during the plan year.