What is Section 125?
Section 125 Plans are one type of group insurance benefits an employer may offer. These Section 125 plans are also called cafeteria plans and flexible benefit plans. These plans were first described in the Internal Revenue Code Section 125 in 1978. However, they didn’t become popular until 1986 when tax laws changed and employees received greater tax benefits.
This code allowed employers to create a separate plan for employees. It provided an opportunity for them to receive fringe benefits on a pretax basis. The IRS strictly regulates all plans and can change their requirements. Written plans must clearly describe all benefits, and set out rules for eligibility and election. Many employers offer these plans through an outside administrator because of their strict guidelines.
What are Flexible Benefit Plans?
Participant contributes money to their Spending Account each payroll by taking money from their paycheck. The money isn’t subject to tax. This money is not subject to tax. The participant’s employer (or an outside Administrator) then reimburses the participant from this account for any health care expenses that are not covered by a policy of insurance or by a provider.
Participant’s expenses will be reimbursed up to the maximum amount allowed by their annual election at time of claim submission. All expenses must be incurred within the plan year. All funds remaining in the Spending Account after the plan year end will be forfeited.
These plans last for one year. The annual election is the time when the participant decides how much to contribute. A participant can have one Spending Account for them (called the Health Care account) and one for their dependents. The Dependent Care Account and Health Care Account are separate accounts. Funds cannot be transferred from one to the other.
Participant should consider their annual elections, including their health insurance copayments and deductibles. Also, uninsured medical and vision care, and hearing care expenses should be considered. Uninsured expenses must be covered if they are “medically necessary”, as determined by a physician or healthcare provider.
When discussing expenses, you may notice some common expense categories. These could include:
> Medical expenses not covered by insurance due to charges incurred for hospital, doctor, dentist, orthodontia and vision.
> Copayments and deductibles for hospital, doctor, dentist, orthodontia, vision and prescription drug charges incurred.
> Long-term rehabilitation services to address drug and alcohol addiction.
> Medical expenses that are eligible for federal income tax purposes.
The eligible expenses are much more. For a complete list of eligible expenses for the year, please refer to the article’s end.
Why is Flexible Benefits Plans Beneficial?
Employer’s perspective, this is an additional benefit for your employees and a way to help them save on taxes.
Employees save taxes while you pay for medical expenses that are not covered by your health insurance or paid for by a provider using money you have set aside through payroll deductions. These expenses are not paid out of your daily cash flow, so you can save money.
You do not have to take pre-tax deductions for premiums, dependent care, or any other out-of pocket medical expenses if you don’t have a 125 plan.
Let’s say that you make $26,000 per year. You would be taxed on $26,000 if you did not take the pre-tax deductions permitted by the 125 Plan. If you don’t have a tax 125 plan, your $26,000 income would be subject to a Federal Income Tax rate of 15%, a State Income Rate of 3%, and a Social Security Tax at 7.65%.
You would pay $19,500 tax if you purchased a 125 plan and paid $1,000 in premiums, $5,000 to child/dependent care, and $500 out-of-pocket expenses, for a total $6,500.
If you had a 125 plan, you would pay $5,002.00 in tax at the same rates as above.
Don’t forget that 125 Plans don’t cover premiums, dependent care, or any other out-of pocket medical expenses up to $6,500.
What does this all mean for your net take-home?
Without 125 Plan:
$26,000 = $12,831
With the HTML125 Plan:
$26,000 = $14,498
Participating in the 125 Plan will bring you an additional $1,667.
Here’s the list of eligible expenses for this year, as promised.
Acupuncture
Treatment for alcoholism
Ambulance service
Artificial limbs
Artificial teeth
Body Scans
Braces
Birth control pills
Braille magazines and books
Installing special hand controls or any other equipment to aid a person with disabilities can cost you money on your car.
Chiropractor
Christian Science Practitioner
Contact lenses, insurance and solutions
Coinsurance
Corrective surgery for a deformity that is directly or indirectly related to a congenital anomaly, an injury sustained in an accident or trauma, or a disfiguring condition.
Crutches
Deductibles
Dental fees
Treatment for drug and alcohol addiction
Eye exams
Eyeglasses
Eye surgery is performed to correct vision acuity (example: laser sight correction).
Guide dog or another animal that can assist people with disabilities
A medical condition may require hair transplants
Batteries and hearing aids
HMO copayments
Home improvements or special equipment that is installed at home to provide medical care
Hospital bills
Immunizations
Inpatient confinement to treat mental or physical injury or illness
Equipment and supplies for glucose and insulin testing
Labor fees
To prevent lead poisoning, remove lead-based paint from walls
Only in retirement homes, a lifetime care fee for medical services
When medical care is the primary focus, lodging expenses are not necessary.
Fees for medical doctors
Plan for medical information
For the treatment of a medical condition, medical supplies are prescribed
Prescriptions for medicine by a doctor, osteopath or dentist.
Cost of special homes for mentally handicapped people
Fees for nurses
Nursing home medical care fees
Obstetrical expenses
Operation
Orthodontia
Orthopedic shoes
Osteopath
There are many over-the-counter medicines available, including pain relievers, allergy medications, and cold medicines.
Oxygen
Podiatrist
Prescriptions (see Medicines).
Prosthesis
Psychiatrist
Psychologist
Participation in a smoking cessation program and prescription medication are the only options
Special schools and education available for people with disabilities, both mentally and physically.
Special equipment for the hearing impaired, such as special telephones and televisions
Surgical fees
Treatments for a medical condition
Transplant expenses include payments for hospital, laboratory, and transportation expenses for a potential donor or donor of a kidney, or any other organ.
Transport expenses are primarily used for and necessary to provide medical care
Special school for the handicapped – Tuition
Walker
If prescribed by a doctor, weight loss program (exclusions food and/or supplement costs)
Exams for well-baby and healthy-child
Wheelchair
A medical condition may require a wig
X-rays
Be aware of ineligible expenses.
Cosmetic surgery and dental expenses for general improvements in appearance, such as face-lifts (electrolysis), hair removal (electrolysis), liposuction (bleaching), and hair transplants (electrolysis).
Institution custodial care
Funeral costs
Health club dues, fitness centers, YMCA membership, spas, massages, etc. for general health improvement
Domestic and household help
Illegal treatment, illegal operations or drug use
Premiums for Long-Term Care, Accident and Life Insurance
Maternity clothing, diaper service, etc.
For overall good health, you can purchase over-the-counter medicines, herbs, vitamins, and nutritional supplements.
Rogaine is not prescribed to treat high blood pressure.
Even though it is not recommended by a doctor for general health improvement, social activities like dance lessons and classes are still encouraged.
Special school for troubled children to receive the anticipated benefits that the child might get from the course and disciplinary methods
Uniforms
Section125 Plans are a great benefit for employers and an excellent benefit for employees.
