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How to Save Tax Dollars with a Section 125 Plan

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It’s no secret that employee salaries and benefits add up to be one of the biggest expenses for a company. Many organizations provide healthcare and other benefits for eligible employees. These benefits may help to attract and retain top talent, but for a budget-conscious business owner, this can feel like a very large expense. Cutting benefits might be an option, but this may not be a practical solution. Employers might even find themselves increasing their offerings to remain competitive in the changing market. In some cases, a business could be subject to certain federal or state rules that dictate the type of benefits and sometimes even the minimum levels of coverage that are required.

Fortunately, there are opportunities for employers to realize some savings when providing certain benefits to their employees through the use of Section 125 cafeteria plans. These are employer-sponsored plans that allow employees to pay for qualified expenses such as health, dental, and other insurance premiums on a pre-tax basis. These plans also allow employees to pick and choose (to some degree) the specific benefits they want, which means employers aren’t paying for all of the offerings for every employee.

For example, let’s say we have an employee with a paycheck of $1,000 (gross), and $150 in healthcare premiums deducted from each biweekly pay.

If the coverage is part of a cafeteria plan, the employee’s take-home pay for the period would be $597.98*.

Without the pre-tax benefit of the section 125 plan, the employee’s take-home pay would result in $553.50*, which is almost $45 less per period. Over the course of a year, that amounts to over $1,150 in additional take-home pay for the employee!

*figures calculated using a marginal rate of 22% for federal income tax, and a combined 7.65% for employee Social Security and Medicare taxes.

Since employers are also subject to Social Security and Medicare taxes, they can also realize some savings from the pre-tax status of these benefits. In the example above, the employer’s share of the tax would be $65.03, versus $76.50 without the pre-tax benefit. A difference of a little over $11 may not seem like a very substantial amount, but multiply that by each employee over every pay period, and the savings can quickly add up.

Section 125 plans can also include certain flexible spending accounts, in addition to health, vision, dental, and other group insurances. A full list of eligible benefits may be found in IRS Publication 15-B. Companies might find this information helpful, as jobseekers may be interested in more than just a salary, and an organization’s benefit offerings can sometimes be the deciding factor for a candidate who is looking for new employment.

In short, section 125 cafeteria plans can help businesses save money and keep employees happy. Of course, as with all things, there are a few drawbacks as well, which may include setup fees and rules on when and how certain funds are to be used or reimbursed. However, in many cases, the tax savings will be enough to offset these costs and the resulting employee satisfaction and retention can prove to be well worth it in the long run.

 

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Christina Hageny

President - Valor Payroll Solutions

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Christina Hageny

President - Valor Payroll Solutions

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