Cafe 125, also known as a “cafeteria” plan, allows employees working for a company, business, or organization to process payments for certain expenses with pre-tax dollars. It is called a cafeteria plan because it provides employees with various options they can choose from when it comes to filing their tax returns to the IRS. However, there’s a catch for these plan options. Employees should agree with a particular salary deduction. On the flip side of it, the IRS doesn’t consider this money as the employees’ wage because the funds of this cafeteria plan are not part of the employee’s salary that they’re getting from their employers.
Section 125 Plan Defined
All employees can take advantage of the Section 125 plans, including their spouses and other dependents. Since the cafeteria plans lower the employees’ salaries, they will see a reduction in their gross wages on their W-2 forms. For instance, if you’re working for a particular company and your annual wage is $50,000 but you receive the cafeteria benefits of $4,000 annually, it means that you will only be paying your legal taxes of $46,000 per year.
Moreover, a lot of employers choose these cafe plans under Internal Revenue Code Section 125 for various reasons. It includes the benefits of health insurance, adoption assistance, dependent care assistance, and even 401k and the group-term life insurance policies. That’s why it is called cafe plans because employees will enjoy the list of benefits they can choose from to lower the legal taxes they need to pay every tax year.
The Cafe 125 Plans on W-2 Forms
On the W-2 forms, taxes from wages are not included on any items of the cafeteria plan, like Social Security, Medicare, and withholding. Because of that, you can’t find the benefits of the cafeteria plan in Box 1 of the W-2 form, which is the space allotted for the employee’s wages. Besides that, the cafe 125 plan is not also found in Box 5 for Medicare and Box 3 for Social security due to the fact that they are not taxable. On top of that, you can’t also see the cafe 125 plan in Box 16, which is a space allocated for tips and state wages.
However, you can find cafe 125 being reported as a code on your W-2 form in Box 14, which is allotted for other items. Also, you can make use of this box 14 to denote some contributions of a pension plan, financial assistance for education, and union dues. So you will use Box 10 on the form if you use the dependent care option for the cafe 125 plan.
Cafe 125 Plan Non-Taxable Benefits
The cafe 125 plan offers various non-taxable benefits that you should know. The good thing about it is that, if you are an employee, you have an option to enjoy these benefits instead of pay. You also have to keep in mind that these benefits are tax-deductible on your income tax form because, in the first place, you were not paying any taxes on these benefits. So the benefits of the cafe 125 that you can take advantage of include:
- group term life insurance
- qualified 401(k) retirement plans
- dependent care assistance, such as daycare
- adoption assistance
- certain health and accident insurance
- flexible spending accounts
- health savings accounts
The Benefits Not Allowed in a Cafe Plan
As discussed above, there will be a list of benefits you will surely enjoy in a cafeteria plan. However, there will also be various benefits that are not allowed in cafe 125, and here are some of them:
- educational expenses
- employee discounts
- employer-provided cellphones
- retirement planning
- Transportation fees
- athletic and exercise facilities
- moving expenses
You may all know about MSAs or the Archer Medical Savings accounts. These MSAs were designed to provide small business owners and self-employed individuals with medical care costs. Because of that, these are not eligible for a cafeteria plan. We made a whole list of tax savings strategies.
Important Thing to Keep in Mind
If you’re an employer, you have an option to break down every contribution you paid to the section 125 plan, or you can have the amount on the form as one payment. Also, if you’re an employee, the cafeteria plan allows you to convert your taxable items into nontaxable ones. In fact, it’s one of the options and the employee benefits you can take advantage of.
So if you’re enrolled in this particular benefit plan, your premiums are taken out from your salary, but it will be on a pretax basis. If you look at your W-2 form, you can see the taxable wages boxes that show your wages where the taxes will be taken out. It is your employer’s responsibility to make sure your W2 is accurate. However, it doesn’t apply to your contributions to section 125. Hence, as an employer who enrolled your employees in this section 125, you can make use the Box 14 on the W-2 form to notate this information using the code “S125.”