Section 125 Cafeteria Plans gives employers the opportunity to offer their employees a variety of health care benefits with the deductions made pre-tax. That is, the employees' premiums for various insurance coverage are deducted from his taxable income, thereby lowering his Federal withholding, FICA tax, and Medicare taxes. In the end, the employer gets to realize tax savings for his share of the taxes, making it a win-win situation for both employee and employer.

But the IRS also has rules set to ensure that the plan's benefit is not subjected to abuse. With most employer-offered benefits, such as pensions and tax-sheltered annuities, the IRS frowns on any effort to exclude the average employee from the plan, or to offer the bulk of plan benefits to the upper echelon of the organization. And that's where nondiscrimination rules come in. And the IRS Section 125 has its own set of parameters for nondiscrimination.

First, a cafeteria plan should not favor "highly compensated" employees. The IRS provision defines highly compensated employees as a. officers; b. shareholders who own over 5% of company stock; c. a highly compensated employee as evidenced by facts and circumstances; and, d. a spouse or the dependents of any of the individuals defined above.

The second rule of nondiscrimination is that the Section 125 plan should not show any partiality to "key employees". The IRS says that this is 1)an officer with annual compensation of more than $160,000; 2) an employee who owns 5% of the business or 3) and employee who owns 1% of the business and whose annual pay is more than $150,000.

The IRS Publication 15 states that should the Section 125 Plan favor HCEs or key employees, you will have to include in (tack onto) their taxable wages the value of the taxable benefits they could have selected. That means more wages for the employer to pay tax on. This also means that the rule would still apply regardless of whether the favored employee will avail of the benefit or not.

Your plan "favors" these groups if more than 25% of the nontaxable benefits for all employees under the plan go to these employees. Any Section 125 plan drawn through a collective bargaining agreement however, is assumed to be in accordance with the nondiscrimination rules.

So, if you're offering a cafeteria plan, you should make sure that 1. the plan is accessible to all employees; and 2. the same types of benefits and amounts should be available to all employees under the plan.

The rules of the IRS code also mandates employers to have their Section 125 plans undergo testing for compliance with nondiscrimination rules at the end of each plan year. So say for instance, your organization's plan is effective from January 1 until December 31, the plan should successfully pass the nondiscrimination testing by or before December 31.

So what's to be learned from all these?. A Section 125 Cafeteria Plan is a great benefit for employees, but the administrative rules can trip up unsuspecting employers. Be vigilant of your plan and see to it that you comply with IRS regulations. If you need help or just don't have the time to do this, consider hiring a professional who can guide you through the minefield.

Visit us at http://taxfreepremiums.com to know you can stay in compliance with your cafeteria plan. You can also find a tax savings calculator that can assist you in determining just how much you'll be able to save with a Section 125 POP Plan.