Section 125 plans are an effective tax planning strategy. This is one of the many strategies that we utilize at Joseph F. Fragnoli, CPA, PC and its affiliate company, Triumph Wealth Management, Inc. in Nashville, TN.
Employers utilize a number of benefit plans for employees. One of the most economical and efficient plans is a section 125 plan. This plan has favorable tax benefits to both the employees and the employer.
A section 125 plan is part of the IRS code that allows employees to take taxable benefits, such salaries and wages, and convert them into nontaxable employee benefits. These benefits may be deducted from an employee’s paycheck before taxes are paid. However, the full compensation is still deducted by the employer. Cafeteria plans are particularly good for participants who have regular expenses related to medical issues and child care. Employees enrolled in a section 125 plan can set aside insurance premiums and other funds pretax, which can then be used on certain qualified medical and child care expenses. As I have preached before, the objective of effective tax planning is to shift expenses that one already incurs from the use of post-tax dollars to the use of pre-tax dollars. The tax savings to the employee is effectively a pay raise.
Section 125 cafeteria plans must be created by an employer. Once a plan is created, the benefits are available to employees, their spouses and dependents.
On the employer side, section 125 plans offer lots of tax-saving benefits. For each participant in the plan, employers save on the FICA tax, the Federal Unemployment Tax Act (FUTA) tax, and State Unemployment Tax Act (SUTA) tax. These savings usually outweigh the cost of plan set-up and administration, on occasion, significantly.
A wide variety of medical and child care expense are eligible for reimbursement under a section 125 cafeteria plan. There are a number of eligible medical and health care expenses that can be reimbursed including, but not limited to: chiropractic services, dental and doctors’ fees, eye exams, hearing aids, long-term care services, nursing homes, operations, prescription drugs, psychiatric services, and wheelchairs. There are a number of commonly used over the counter items that are also qualified expenses.
There is a rule in place that states you must use any remaining funds in the account by the end of the year or the money is forfeited to your employer. Although this may be true, it may still result in a net benefit to the employee. The tax savings will usually outweigh any small amount of unused funds. We recommend that the employee carefully schedule out known expenses and estimate projected expenses to determine the amount to set aside. There is a carryover provision that was implemented in 2013. With the provision, plan participants can carry over $500 of unused funds from one year to the next.
There are a number of ways to set-up a section 125 cafeteria plan. Discuss this program with your medical insurance agent, investment advisor or CPA. If you would like to discuss the plan option with me, or any other tax planning strategies, please feel free to call me at (615) 678-4751.
Note, some of the content of this article was derived from an article written in AccountantsWorld Daily News by Craig Anthony.