Since its creation in the 1970s, many American workers and employers have taken advantage of the tax benefits to be had under Section 125 of the IRS code in the form of cafeteria plans — plans that allow employees to contribute a pre-tax portion of their income to benefits like medical or dependent care or even some transportation expenses. The tax advantage of these plans is so great that traditionally, they have been a valuable tool for employers because they end up being so lucrative for employees. Workers see a break on federal, state and income taxes that can be as large as 20 percent – 40 percent of their income deductions. Further, employers save substantially on Social Security and Medicare taxes, somewhere around 7.5 percent.
But in the mad dash to pass a GOP tax plan by the end of the year, could Section 125 Cafeteria Plan deductions be in trouble?
Section 125 Cafeteria Plans: What You Need to Know
Before we dive into the potential changes to Section 125 Cafeteria Forms in a theoretical GOP tax reform package, it is helpful to have some background information about what the plans do and how they are used.
What are Section 125 Cafeteria Plans?
Cafeteria Plans that are covered under Section 125 are benefits that allow employees and employers to contribute to various things like health coverage, dependent care and adoption costs without paying income taxes on their contributions. So while total compensation may go up, the tax liability does not.
Section 125 v. Section 105
Section 125 Cafeteria Plans are very similar to plans that fall under Section 105, however they are not to be confused. While Section 105 plans allow employers to reimburse employees for the unsubsidized premiums paid toward a government-sponsored health plan, those transactions do not qualify for Section 125.
The GOP Tax Plan’s Impact on Section 125 Cafeteria Plans
Since the United States House and Senate passed their own version of the GOP tax plan, they have been hustling to try to find a compromise that will earn the necessary number of votes in each chamber and that can be passed by the end of the year. In fact, text of the bill is expected as soon as Friday of this week. While nothing is certain until legislation actually passes, experts and politicians have been weighing in on the potential tax reforms coming down the pipe.
At least as early as October, some have voiced concern that the tax benefits of plans like the Cafeteria Plans that fall under Section 125 could be in jeopardy. Although not explicitly targeted in early drafts of the bills, some politicos see it as a potential bargaining chip for politicians looking to generate new revenue to offset proposed tax cuts in other areas. The Treasury Department estimates that eliminating the tax benefits of these types of plans could generate as much as $69.4 billion, while others have cited an even larger number – $342 billion (5.5 times the size of the mortgage-interest deduction) – as the amount of revenue that would have been generated in 2016 had employees and employers paid taxes on their contributions to Cafeteria Plans.
In at least one draft of the legislation, Section 137, which allows for adoption assistance to be included in a Section 125 plan, would be repealed. This would lead not only to some difficult financial decisions for people currently using pretax income to save for adoption, but for employers who offer this as a benefit for their employees.
With the clock ticking on President Trump’s stated deadline and some politicians still unsure of if they are even going to vote in favor of the GOP tax plan, the bottom line is to be prepared for anything. If you currently offer Section 125 Cafeteria Plans to your employees and are concerned about the implications that the bill could have for your tax bill and your workers’, the time to start familiarizing yourself with other HR solutions is now. Employees will want answers and you need to be prepared to explain the implications.
That’s where we come in. Our accounting and tax experts are up to date on all of the latest regulations and trends in their arena, and they are eager to partner with your business to create and maximize win-wins for you and your employees wherever possible. Do you have a specific question or just don’t know where to start in general? Call us up! After gathering some information about your organization, we will be able to give you advice tailored to you.