What is a Section 125 Premium Only Plan?

IRS Section 125 Premium Only Plans were introduced by the Revenue Act of 1978. These plans allow employers to reduce payroll taxes by making one simple adjustment to the payroll process. Under a Section 125 Premium Only Plan employees elect to pay their portion of health insurance premiums on a pre-tax or tax-free basis rather than on an after-tax basis. This creates savings for both the employee and the employer.

Just one employee pre-taxing $50 a week in premium ($2,600/year) saves up to $1,040 in payroll taxes. The employer also saves up to 10% or $260 by reducing matching payroll taxes for each employee participating. The $350 one-time plan document fee is quickly recouped in payroll tax savings.

How Employees Benefit from a Premium Only Plan.

Employees save 20 to 40% of their pre-tax Section 125 premium deductions. The tax savings are on city, state, and federal income taxes, including Social Security and Medicare taxes on money used to pay for their portion of insurance premiums. Employees take-home pay is increased which helps reduce the cost of providing health coverage for family members.

How Employers Benefit from a Premium Only Plan.

Employers benefit by reducing the matching Social Security and Medicare taxes (7.65%), and sometimes Federal and State unemployment taxes (up to 10%). Depending on the state, employers may also be eligible for worker’s compensation savings (2% to 50%).

Who Can Participate?

Employees of regular corporations, S corporations, limited liability companies (LLCs), partnerships, sole proprietors, professional corporations, and not-for-profits can all reduce payroll taxes by establishing a Section 125 Premium Only Plan. While the Code prohibits a sole proprietor, partner, members of an LLC (in most cases), or individuals owning more than 2% of an S corporation from participating in the Section 125 POP, owners may still benefit from the savings on payroll taxes by sponsoring the plan for their employees.