What is Section 125?
Section 125 refers to Section 125 of the Internal Revenue Code. This section provides that if an employee is given a choice between taking pay or taking a benefit (medical and/or dental insurance) offered by the employer, the employee will not be subject to income tax for electing the benefit. The employer also receives a tax benefit because the contributions to the Section 125 Premium Conversion Plan are not subject to payroll taxes.
Who can participate in the Section 125 Premium Conversion Plan?
All employees who are treated as employed by a single employer under subsections (b), (c), or (m) of Section 414 are treated as employed by a single employer for purposes of Section 125 and are eligible to participate in the Section 125 Premium Conversion Plan.
Who cannot participate in the Section 125 Premium Conversion Plan?
Ineligible individuals include sole proprietors, partners and 2% or more owners of S-Corporations including spouses. Allowing ineligible individuals to participate in your Section 125 Premium Conversion Plan could cause the entire plan to be disqualified, resulting in taxation to all participants.
Must a premium conversion plan be in writing?
Yes, because a Premium Conversion Plan is a type of cafeteria plan, all of the rules of Code Section 125 apply, including a written plan document. Failure to follow the terms of the written plan document provisions may result in dis- qualification of the Premium Conversion Plan. Should your plan need to be amended and/or restated, please contact Benefit Extras.
Does the written plan have to be filed with any government agency?
No, you are not required to submit the Section 125 Premium Conversion Plan to the IRS or any government agency. However, the IRS and the Department of Labor are free to audit the operations of the plan, and during such a review, you may be asked to submit plan documents that meet the requirements of Section 125.
Are there any disclosure requirements to employees participating in the Premium Conversion Plan?
Section 125 does not impose any specific requirements as to what information must be disclosed to Premium Conversion Plan participants. Benefit Extras has provided you a Summary Plan Description that we recommend be distributed at the time an employee enrolls under the Premium Conversion Plan.
How does an employee elect to participate in the Premium Conversion Plan?
With regard to an employee’s initial Premium Conversion Plan election, Section 125 is most conservatively interpreted as requiring an affirmative election. Benefit Extras has provided an enrollment form with your materials that may be completed by employees electing to participate in the Premium Conversion Plan. After a plan participant makes an initial election, it is generally viewed as an acceptable administrative practice to allow the plan to revert to a default mode under which those elections remain in force until an employee makes an affirmative election to change them.
When can an employee change their Premium Conversion Plan election?
Outside of the open enrollment period, there are actually quite a few situations which would allow an employee to change their election. These are referred to as “change in status” events. Most, but not all, of the reasons for which an employee might want to change their election is included in the change of status events. For example, marriage, divorce, birth or adoption of a child, death of a spouse or child, commencement or termination of spouse’s employment are all change in status events. The change in enrollment must be consistent with the change in status event.
What discrimination rules apply to the Section 125 Premium Conversion Plan?
Section 125 indicates that a cafeteria plan cannot discriminate in favor of highly compensated individuals as to eligibility to participate in the plan and is prohibited from discrimination in favor of highly compensated participants as to benefits or contributions. In addition to the above two rules, cafeteria plans are subject to a 25% key employee concentration test.
Are there annual reporting requirements, i.e. IRS Form 5500?
Code 6039D used to require that a cafeteria plan sponsor file an annual return on Form 5500 for its cafeteria plan, including limited financial information on Schedule F. This reporting requirement has been suspended. However, any ERISA plans (such as health insurance or a health FSA) offered under the cafeteria plan are still subject to ERISA’s annual reporting requirements, unless an exemption applies. Please contact your accountant if you have any questions regarding the filing requirements under ERISA.
This is not intended to give legal or accounting advice, but to simplify your understanding of the IRS rules and how they pertain to Section 125. This is only meant as an overview.