What is a cafeteria plan?

A cafeteria plan (Section 125 plan) allows employees to choose between taxable cash compensation and qualified pre-tax benefits such as health insurance and flexible spending accounts. For professional service firms, cafeteria plans offer tax savings for both employers and employees.

Key characteristics

• Choice between cash and benefits

• Pre-tax treatment for benefits

• Section 125 of the tax code

• Requires a plan document

• Non-discrimination rules apply

• Reduces payroll taxes

Why it matters for professional service firms

Cafeteria plans make benefit contributions pre-tax, saving both income tax and FICA. Employees get more value; employers save on payroll taxes. Professional service firms offering health benefits should consider a cafeteria plan structure to maximize tax efficiency.

Real-world example

Brian's firm paid $800 monthly toward employee health insurance. Without a cafeteria plan, $800 of compensation was taxable, and the employee paid a post-tax premium. With cafeteria plan: $800 premium deducted pre-tax. Employee saved approximately $3,000 annually in taxes. Employer saved $1,100 annually in FICA on the pre-tax amount.