Establishing Section 125 "cafeteria" plans for a small business

I am trying to establish a Section 125 plan for our small business.

Section 125 plans allow for flexible spending accounts for the following purposes, documented at

  • Accident and health benefits (but not Archer medical savings accounts (Archer MSAs) or long-term care insurance).
  • Adoption assistance.
  • Dependent care assistance.
  • Group-term life insurance coverage (including costs that can’t be excluded from wages).
  • Health savings accounts (HSAs). Distributions from an HSA may be used to pay eligible long-term care insurance premiums or qualified long-term care services.

We have at least 4 employees who would benefit from this. Aside from the obvious benefit of enabling them to shelter income from taxes, it looks like it should help some of them enjoy more substantial ACA subsidies.

Has anyone set this up for their small business? Any resources, vendors, tricks, or other techniques you’d recommend? TIA


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It’s pretty easy to setup. However, whatever “benefits” you give yourself, you must give to your employees. It’s best to have a CPA set it up to confirm you’re in accordance with KGB regulations.

Hi Greatness, thanks for replying.

Have you been through the process?

We are thinking to have a lawyer set it up, as it needs to be a compliant Section 125 document. But it makes sense that many CPA firms would have compliant templates.

I’m not sure we’d even give these benefits to partners at all. First of all, it seems we can’t give health benefits to partners owning 2% of the company.

Second, I’m concerned that giving these to partners will make them look more like “employees” of the company, which it appears will be one of the tests used to establish eligibility for the new passive income deduction under the Trump tax act.

Yes, I’ve had it successfully setup and no issues. It’s easier with a one person LLC than with employees though. IANAL or a CPA, however, if you transfer the part of the LLC’s ownership into a trust, then the original owners can take advantage of the benefits. You need to weigh the benefits for that. That is the only way I know of legally getting around the 2% rule. Again, you need to run this by an estate attorney or CPA within your State to confirm it also in compliance with with the State’s dept. of revenue.

Interesting. I take it your CPA blessed the trust workaround?

How long has it been in place? Do you do just health, or a broader array of benefits?

Have you thought about converting your business to a C Corp? May not be wise or possible, but something to consider if your goal is to get around the 2% rule.

Thanks Full_Disclosure.

We haven’t had reason to consider it, but aren’t opposed to the idea in principle if the benefits outweighed the costs.

Not only has she blessed it, her firm (who has attorneys on staff) put both docs together. It’s setup just for health and medical reimbursement. I never needed to add anything else. It’s one of the reasons why I went to firm to handle everything instead of using an online service. It’s just safer and more reassuring with a third party’s stamp of approval.

If he is a more than 2% owner or more of the C-Corp, he’ll have the same issue. Hence, the only legal way would be for a trust to own the entity.

Thanks Greatness. What did the setup and docs cost you, approximately?

Another question: what are your logisitics for FSA accounts?

Do you outsource these to a payroll company, or a provider like Zenifits?

Not sure what issue you’re referring to, but the 2% rule I’m referring to (S Corp owners with at least 2% ownership being disallowed from receiving various fringe benefits tax free) does not apply to C Corps. Of course, there are other limitations which apply to C Corps (non-discrimination, etc.)

How is your trust structured and who are the trustees and beneficiaries? OP probably needs to keep Section 318 in mind.

I think WageWorks is one of the large benefit administrators:

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I believe it was around $1500.00 to setup everything. Wasn’t too bad. As for FSA’s, I do not use that option. All medical expenses allowed under Section 129 of the IRS code are automatically reimbursed to the employees and the expense is taken by the company.

I am not a CPA, so cannot comment on this setup. I just know the setup that I have done through a CPA and attorney is in regulations with NY and the Feds. The trustees and beneficiaries are not me. Though, you may be able to get by with a revocable trust as well. Not sure. You’d need to run that by a CPA and elder law attorney. As always, you want to have in writing from whomever sets this up for you that this is setup within the current laws and regulations acceptable to section 129 of the IRS code. Reason being, if ever challenged, you can show that your representative set everything up and certified all is within the State and Federal regulations.

Thanks Greatness. $1,500 doesn’t seem bad to have to have done and vetted by pros, esp with the trust component.

Your strategegy makes sense: just having a company sponsored health insurance plan is a simple way to go. If you don’t have dependent care expenses and don’t use an HSA, an FSA on top of that would likely be unattractive.

Full_Disclosure, I hear you on Section 318. I don’t want to get cute on constructive stock ownership. But aren’t c-corps as subject to non-discrimination provisions as S-corps are?

From what my CPA told me, the IRS looks more closely at S-Corps and partnerships as they are easy low hanging fruit. However, since Section 129 is geared more towards medium to large sized corps, one has to be in compliance in order to reap those benefits. However, you need to have your accountant run the #'s to ensure you are not paying more in taxes on the income.

Did you mean Section 125 in your last post, Greatness?

They’re both subject to nondescrimination testing, but with S Corps most rarely get to that test because the 2% shareholder test takes them out of fringe benefits. So while S Corps are still subject to nondescrimination rules, those rules aren’t as relevant.