How employers lower FICA payroll taxes with a Section 125 plan
A Section 125 cafeteria plan lets employees pay for qualified benefits with pre-tax salary reductions. Those amounts are generally not subject to Social Security and Medicare tax, so the employer does not owe its 7.65% share of FICA on them.
What FICA costs an employer
Employers pay 6.2% Social Security tax on each employee's wages up to the annual wage base, plus 1.45% Medicare tax on all wages. Together that is 7.65% on most pay. Employees pay the same percentages from their checks.
What a Section 125 plan changes
Under a written cafeteria plan, an employee can choose to have part of their pay go toward qualified benefits before taxes are calculated. That portion is generally excluded from federal income tax and from FICA wages. Lower FICA wages mean a lower FICA bill for both the employee and the employer.
A simple illustration
If an employee directs $100 of pay to a qualified benefit through a Section 125 plan, the employer generally owes $7.65 less in FICA on that paycheck. Multiply that by every pay period and every participating employee and it adds up. Actual results depend on pay levels, participation and state rules, and some states treat cafeteria plan amounts differently for state taxes.
What counts as a qualified benefit
Common examples are employee contributions toward group health, dental and vision coverage, health flexible spending accounts and dependent care assistance. Not everything qualifies, and the plan document must list what is offered.
What employers must do
- Adopt a written plan before salary reductions start.
- Follow the election rules. Employees generally choose once a year and can change mid-year only for permitted events.
- Run nondiscrimination testing so the plan does not favor highly compensated or key employees.
- Set up payroll correctly so pre-tax amounts are coded and reported properly on Form W-2.
Trade-offs to explain to employees
Because Social Security benefits are based on FICA wages, lowering those wages can slightly reduce an employee's future Social Security benefit. Other wage-based items can be affected too. Employees should hear this plainly before they enroll.
Where newer programs fit
Some programs combine a Section 125 plan with a self-insured medical reimbursement plan and preventive care services. The Section 125 mechanics above are well established. The rest of the design deserves a careful look, especially how any payments back to employees are treated.
Common questions
How much can an employer save with a Section 125 plan?
Generally 7.65% of the pre-tax amounts employees run through the plan, up to the Social Security wage base for the 6.2% portion. Totals depend on participation and pay.
Do employees save too?
Yes. Pre-tax contributions generally lower an employee's federal income tax and FICA, and in most states their state income tax as well.
Is a written plan document required?
Yes. A Section 125 plan must be in writing and adopted before pre-tax salary reductions begin.
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Book a free callThis article is general information, not tax, legal, accounting, insurance or benefits advice. Everlasting Benefits Group is an independent sales representative for third-party plan administrators and may be paid by them when an employer adopts a plan. We are not a plan administrator, insurer, law firm or accounting firm. Tax rules change and results vary by state, payroll and plan design. Talk with your own CPA or attorney before adopting any plan.