Section 125 Cafeteria Plans: The Payroll Tax Break Most Florida Employers Skip

If your employees pay part of their health premium and those dollars are not running through a Section 125 plan, you are overpaying payroll tax on every one of them. The fix is a plan document and some annual testing. The savings are automatic and permanent.

What a Section 125 Plan Is

A Section 125 cafeteria plan — often sold in its simplest form as a Premium Only Plan or POP — is a written arrangement that lets employees elect to receive certain benefits instead of taxable cash. In the most common version, the only election is whether to pay their share of the health insurance premium.

The mechanism is straightforward. IRS Publication 15-B provides that qualified benefits selected under a cafeteria plan are excluded from federal income tax withholding and from social security and Medicare taxes. Those dollars leave the FICA wage base entirely.

What makes this worth writing about is that it is one of the very few genuinely free lunches in employee benefits. There is no trade-off, no risk transfer, no downside. There is a plan document, some annual testing, and then permanently lower payroll taxes.

The Math

Employer-side FICA is 7.65%: 6.2% for Social Security and 1.45% for Medicare. Every dollar an employee runs through a Section 125 plan is a dollar you do not pay 7.65% on.

Add federal unemployment tax and Florida reemployment tax savings on wages below those bases, and the total is somewhat higher than the FICA figure alone.

The employee saves more than you do. Someone in the 22% federal bracket contributing $150 a month avoids roughly 22% income tax withholding plus their own 7.65% FICA — about $53 a month, or $636 a year. Florida has no state income tax, so there is no additional state saving, but there is also no state complication.

That employee-side saving is worth mentioning to your team explicitly. A $150 monthly contribution that costs an employee $107 in take-home pay is a materially different proposition than one that costs $150, and most employees have no idea the difference exists.

Two Limits on the Savings

Both matter for accuracy, and both get glossed over in benefits marketing.

The Social Security wage base

The 6.2% Social Security portion only applies to wages up to the annual wage base — $184,500 for 2026. Above that, you are only saving the 1.45% Medicare portion. For a company with several highly compensated employees, the blended saving is below 7.65%.

The Additional Medicare Tax

The 0.9% Additional Medicare Tax on wages over $200,000 is employee-only — there is no employer match. It produces no employer saving at all.

The accurate way to state this: employers generally save 7.65% in FICA on every dollar employees run through a Section 125 plan, up to the Social Security wage base of $184,500 in 2026; above that, savings drop to 1.45%.

What You Actually Have to Do

The compliance bar is low but it is not zero, and the failure mode is unforgiving.

A written plan document, adopted on or before the first day of the plan year. Required contents include a description of the available benefits, eligibility and participation rules, election procedures, the manner in which contributions are made, the plan year, and — for health FSAs — the maximum benefit and any carryover or grace period provisions.

Practically, most payroll providers and third-party administrators will produce a compliant POP document for a few hundred dollars. Against thousands in annual savings, this is not a close call — which makes it genuinely puzzling how many employers offering coverage still don't have one.

Nondiscrimination Testing

Three tests apply annually to the cafeteria plan itself:

1. Eligibility test — enough non-highly-compensated individuals must be eligible, the waiting period must not be excessive, and the classification must not be discriminatory.
2. Contributions and benefits test — benefits must be available and utilized on a nondiscriminatory basis. This examines whether highly compensated individuals elected benefits to a greater extent than others.
3. Key employee concentration test — key employees must not receive more than 25% of the aggregate nontaxable benefits provided under the plan.

Component benefits carry their own separate tests: Section 105(h) for self-insured medical benefits and Section 129 for dependent care assistance. Whoever administers your plan should run all of these; ask specifically whether testing is included in what you are paying for.

For a small employer where everyone gets the same benefit on the same terms, testing is usually a formality. It becomes a real issue where owners and executives receive richer benefits than staff.

Who Cannot Participate

This is where entity structure suddenly matters, and where errors cluster.

IRS Publication 15-B states it directly: do not treat a 2% shareholder of an S corporation as an employee of the corporation for this purpose.

If you are a more-than-2% S-corp shareholder, your path is different rather than absent. Your health insurance premiums are included in your W-2 wages, and you then deduct them on your personal return under IRC § 162(l). This produces a comparable income tax result but not the FICA saving, and it is set up incorrectly frequently enough that it is a known audit exposure. Coordinate your CPA and your benefits advisor on this specifically — they are often not talking to each other.

The ICHRA Complication

One rule that catches employers moving away from group coverage.

The Internal Revenue Code prohibits employers from allowing employees to pay for Exchange coverage on a pre-tax basis. If you offer an ICHRA and your employees buy on HealthCare.gov, they cannot run the residual premium through a Section 125 plan.

You can use Section 125 to pre-tax the residual on off-Exchange individual coverage under an ICHRA. That is a real workaround, and it is one of the reasons some ICHRA designs steer employees toward off-exchange plans — though doing so also removes access to premium tax credits, which for many employees is the more valuable thing.

This is precisely what H.R. 6703 would change. That bill would permit pre-tax Section 125 treatment for Exchange coverage under what it calls a CHOICE Arrangement. It passed the House 216 to 211 on December 17, 2025 and has not been enacted as of August 2026. More on ICHRA design here.

What to Do

1. Check whether you already have one. Many employers have a POP document from years ago sitting in a file. Confirm it exists, that it covers your current plan year, and that its terms match what you are actually doing.
2. If you don't, get one before your next plan year starts. Not mid-year — the document must be adopted on or before the first day of the plan year to work for that year.
3. Confirm testing is being done. Ask your payroll provider or administrator directly. "We assumed someone was handling it" is a common and expensive answer.
4. Sort out owner treatment with your CPA. Especially if you are an S corporation.
5. Tell your employees. The pre-tax saving is the single easiest way to make your benefit package feel more valuable without spending a dollar more.

We look at contribution structure and Section 125 setup as part of every group quote — it is often the fastest money we find for a client. Send us your census and we'll check it alongside your rates.

Section 125 Plans: FAQs