Premium Only Plans
A Section 125 Premium Only Plan, otherwise known as a Cafeteria plan or POP plan, is simply a program that employers can use to help employees pay for certain expenses, such as health insurance and dependent care, with pre-tax dollars.
Employer Advantages in a POP Plan
With the POP, the employer provides the same insurance coverage (e.g., health or dental) that it did before. The underlying benefits have not changed, just the way they are financed.
A cafeteria plan helps employers in many ways. In addition to enabling the employer to save on its share of FICA (Social Security and Medicare) and FUTA (federal unemployment) taxes, a cafeteria plan can:
- help recruit and retain employees;
- increase flexibility to design employee benefits for diverse employee needs;
- in some states, save on state unemployment insurance and workers’ compensation taxes;
- cushion the blow of premium increases; and
- increase employee awareness of the cost of each benefit.
Employee Advantages in a POP Plan
Employees who participate in a cafeteria plan may experience the following advantages and disadvantages.
Advantages for Employees
The extent of an employee’s advantages arising from cafeteria plan participation will depend on the employee’s tax status, the amount of his or her taxable income and pre-tax salary reduction elections, the scope of state and local laws, and the cafeteria plan’s features.
No Federal Income Tax
Employees do not have to pay federal income tax on salary reduction amounts to a cafeteria plan-employees can buy qualified benefits with pre-tax dollars. And if a plan with employer contributions offers a cash-out option, employees who take health coverage or other benefits instead of cash will not be taxed on the cash that they could have received (but chose not to receive).
No FICA, FUTA, or RRTA Tax
There are no Social Security and Medicare (FICA) taxes, federal unemployment (FUTA) taxes, or Railroad Retirement Tax Act (RRTA) taxes on pre-tax salary reductions under a cafeteria plan. FICA, FUTA, and RRTA wages do not include any payment made to, or on behalf of, an employee or his or her beneficiary under a Code §125 cafeteria plan, if (1) the payment would not be treated as wages without regard to the plan; and (2) it is reasonable to believe (if Code §125 applied) that Code §125 would not treat any wages as constructively received.
State and Local Taxes
Most state and local governments treat cafeteria plan elections favorably for state and local income tax purposes. States vary as to how they treat cafeteria plan elections for purposes of state unemployment compensation taxes and workers’ compensation taxes (e.g., some states do not recognize cafeteria plan salary reductions, and they base such taxes on gross pay before cafeteria plan salary reductions).
Setting up a POP Plan
Prepare the Plan Documents, Subject to Attorney Review
The plan document must meet specific legal requirements under the Internal Revenue Code (the Code), so the employer should make sure that the plan document is prepared or reviewed by an attorney. The employer can satisfy the Code’s requirements for a POP with a single plan document. The employer should already have separate plan documents for the insurance plans covered under the POP.
Adopt the Plan Through Board Resolution, etc.
The employer must adopt the plan before its effective date. Adoption of a plan generally requires the same kind of documentation that an entity uses for other major business actions. As a corporation, the employer should adopt the plan by a valid board resolution.
Distribute the Communication Documents to Employees, etc.
The employer needs to tell their employees what the POP does and help them to understand their options. This can be done through a cafeteria plan summary and election form. The employer should also confirm that employees have already received summary plan descriptions (SPDs) for all of the insurance benefits that they can choose under the POP.
Obtain Elections From Employees
Before the plan’s effective date, employees should complete and submit elections reflecting whether they want to pay for their share of insurance costs with pre-tax dollars. The elections should specifically authorize payroll to make those pre-tax deductions.
Instruct Payroll to Deduct Premiums Pre-Tax
Upon receiving the signed election forms, the employer should enter the elections into the payroll system. This requires telling the person who prepares payroll (either internal staff or the outside vendor, if any) to start deducting the employees’ shares of their insurance premiums on a pre-tax basis. The result is that income tax withholding and FICA withholding will be based on each employee’s reduced wages (gross pay, less the pre-tax deductions).
Employees’ pay stubs covering the first pay period will look different than they did before. Their salaries will still be reduced to reflect payment for insurance costs. However, the stubs will reflect less taxable wages and more take-home pay than if employees had used their salaries to pay for coverage with after-tax dollars.
Sample Tax Savings With a POP
Employee “A” is married, has one child, and pays $6,400 in premiums for family coverage under their employers health insurance plan. In 2018, this employee earns $75,000 and her husband (a student) earns no income. They file a joint tax return.
|POP/Cafeteria Plan||No Cafeteria Plan|
|1.||Adjusted Gross Income||$75,000||$75,000|
|2.||Salary Reductions for Premiums||($6,400)||$0|
|3.||W-2 Gross Wages||$68,600||$75,000|
|6.||W-2 Gross Wages||$68,600||$75,000|
|7.||Federal Income Tax||($4,971)||($5,739)|
|8.||FICA Tax (7.65% of line 3)||($5,248)||($5,738)|
|9.||After-Tax Premium Payments||$0||($6,400)|
|10.||Pay After Taxes and Premium Payments||$58,381||$57,123|
Premium Only Plan FAQs
Which Individuals Are Ineligible to Participate in a Cafeteria Plan?
Self-Employed Individuals Cannot Participate (but Their Employee-Spouses and Other Family Members Who Are Employees May Participate, in Some Cases)
Members of LLCs and Partners in LLPs Generally Cannot Participate
Partners in a Partnership Cannot Participate (but Their Employee-Spouses and Other Family Members Who Are Employees May Participate, in Some Cases)
More-Than-2% Shareholders in a Subchapter S Corporation Cannot Participate (Nor Can Their Employee-Spouses or Certain Other Family Members Who Are Employees). Like a sole proprietorship, a Sub chapter S corporation can have a cafeteria plan for its common-law employees. Unlike in a sole proprietorship, however, neither the employee-spouse of the more-than-2% shareholder, nor the more-than-2% shareholder’s children, parents, and grandparents can participate in the Sub chapter S corporation’s cafeteria plan. This is because of the ownership attribution rules