What is a Section 125 plan?

A Section 125 plan is a written document that provides employees with a range of options for their compensation, including both eligible benefits (such as health insurance) and cash. Pre-tax contributions are made to employee benefit plans. Section 125 plans are beneficial for employees, their spouses, and their dependents.

The Internal Revenue Service recognizes the following benefits as qualifying under Section 125 plans1:

Who Doesn’t Qualify for Section 125?

Specific workers are ineligible to enroll in Section 125 plans even though the plans are open to the majority of employees.

  • 1099 workers.
  • Collaboration partners.
  • The LLC’s Members.
  • Owners of more than 2% of the S company.

How to set up a Section 125 Plan?

Creating a Section 125 plan can be complicated, so it’s best to consult with a benefits professional or attorney to make sure everything is done properly and in accordance with the law.

There are a few things you’ll need to do to get your Section 125 plan up and running, so read up on the rules and regulations first. Here’s a high-level look at what goes into creating a Section 125 plan.

  • Prepare the required plan documentation.
  • Inform your staff that a Section 125 cafeteria plan is available.
  • Work with a third-party administrator (TPA) to manage your Section 125 plan and claims.

You must conduct yearly nondiscrimination testing after you begin providing your Section 125 plan. In case of an audit, you should save all test results on file.

Your organization’s nondiscrimination plan must satisfy these three tests:


There should be no special accommodations made in the plan for the company’s highest-paid key workers.

Advantages and investments

The benefits and contributions you provide must be just as accessible to workers of varying income levels as eligibility does.


The value of the perks you offer your key workers must not exceed 25% of the total value of the benefits you offer your employees as a whole.

Also, See: Social Security Administration (SSA)

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